Shorts were right about ArthroCare

Roddy Boyd wrote about AthroCare (a Texas-based supplier of surgical devices) in Fortune about a year ago.

AthroCare's pride and joy is its Coblation technology, which (I quote from its website here), "uses low-temperature radio frequency energy to gently and precisely dissolve rather than burn soft tissue."

Boyd conveyed, rather sympathetically, the complaints of the company bigwigs that they were under an unjustified short-seller's siege. The company "has done admirably" he said, "in nearly every area traditionally used to judge a company's performance."

So why, he wondered aloud, was its stock price going down? Perhaps because short sellers (who "by definition" he reminded his readers "have an interest in a stock's going down" -- do Fortune readers need to be told this?) were spreading misconceptions about its relationship with a particular billings services provider.

The billings company, DiscoCare, was in time acquired by AthroCare. That change in the design of the corporate flow-chart didn't bring an end to the questions. Boyd said artfully that the purchase "made the short sellers go nuts."

If the shorts are wrong about this, Boyd cautioned, then ArthroCare had as of a year ago "lost $700 million in capitalization for no good reason," and there is a "human cost" measured for example in the aggravation felt by the CEO's ill father, who surfs the internet and reads the "innuendos."

This seems to be one of a growing list of cases (Enron itself was one, so was the now-forgotten AremisSoft click here) in which a company starts off criticizing the short sellers for spreading vicious rumors and ends up admitting that, yes, there was some truth to them.

Michael Baker, the CEO who complained to Boyd about the harm the "innuendo" was doing to his sick father, has now vacated that office. The company said Wednesday that it is under formal investigation by the SEC and is the subject of investigations as well by two US Attorney's offices.

The release telling us this also says: "The Company has sent a notice of claim pursuant to the Escrow Agreement established in connection with the Company's acquisition of DiscoCare to the sole selling stockholder of DiscoCare alleging breaches of certain representations and warranties in the stock purchase agreement. The notice of claim is intended to have the effect of preventing the release of $1.5 million in escrow and can lead to further proceedings against the sole selling stockholder. The Company expects the notice of claim to be disputed in arbitration proceedings."

So: "we bought a pig in a poke when we bought DiscoCare" is now the official company position -- it is no longer a possibility stigmatized as "innuendo"!

I am reminded of comments by Jonathan R. Macey, in his recent book Corporate Governance, in which he compares short selling with corporate "whistle blowing" of the Sherron Watkins sort. "Short selling is likely to be a far more credible signal [of real trouble at a company] than whistle-blowing, because the talk involved in whistle-blowing is cheap, while the trading involved in short selling is costly to the short seller whose information about the underlying company is erroneous."