Stryker unit OtisMed Corp. and its former chief executive officer admitted to intentionally distributing knee replacement surgery cutting guides after their application for marketing clearance had been rejected by the Food and Drug Administration (FDA).

OtisMed will plead guilty and pay more than $80 million to resolve its related criminal and civil liability.

The OtisMed plea agreement with the government contains a side non prosecution agreement with Stryker in which the government promises not to criminally prosecute Stryker. In that agreement, Stryker agrees to conduct a review and audit regarding whether other marketed devices have the appropriate FDA approvals and share the results of that audit with the government.  Stryker also agrees to annual certifications from the president of Stryker’s orthopedics group and from Stryker’s board of directors regarding the effectiveness of the compliance program.

Stryker and OtisMed were represented by Brien O’Connor and Joshua Levy at Ropes & Gray in Boston.

OtisMed and its CEO, Charlie Chi, 45, of San Francisco, pled guilty in federal court in Newark, New Jersey.

OtisMed pled guilty before U.S. District Judge Claire C. Cecchi to an information charging it with distributing, with the intent to defraud and mislead, adulterated medical devices into interstate commerce in violation of the Food, Drug, and Cosmetic Act (FDCA).

Judge Cecchi fined OtisMed $34.4 million and ordered $5.16 million in criminal forfeiture.

In a separate civil settlement, OtisMed agreed to pay $40 million plus interest to resolve its civil liability.

Chi pled guilty before U.S. Magistrate Judge Mark Falk to three counts of introducing adulterated medical devices in interstate commerce.

Chi will be sentenced by Judge Cecchi on March 18, 2015.

The civil settlement resolves claims filed under the whistleblower provisions of the False Claims Act, which permit private parties to file suit on behalf of the United States and obtain a portion of the government’s recovery.

OtisMed was a privately held company when OtisMed and Chi committed the criminal conduct, and was later acquired by Stryker Corp., a medical technology company based in Michigan, in November 2009.

At the time the shipments were made in September 2009, Stryker executives were not aware that OtisMed and Chi had shipped cutting guides after the FDA had rejected the company’s application for marketing clearance for the device.

Stryker, OtisMed’s parent corporation, cooperated with the government with regard to OtisMed’s pre-acquisition conduct throughout the investigation.

In addition to the criminal pleas and civil resolution, OtisMed also agreed to be excluded from participating in all federal health care programs for a period of 20 years and Stryker separately agreed to a series of compliance measures aimed at preventing future misconduct.

Chi was among the founders of OtisMed in August 2005, and conceived of the OtisKnee orthopedic cutting guide, its primary product.

Chi acted as OtisMed’s president, CEO and board of directors’ chairman until OtisMed was acquired by Stryker in November 2009.

The OtisKnee was used by surgeons during total knee arthroplasty (TKA), commonly known as knee replacement surgery.

The surgical procedure requires a surgeon to remove the ends of the leg bones and to reshape the remaining bone to accommodate the implantation of an artificial knee prosthesis.

The cuts to the bone must be made at precise angles because they are critical to the clinical result; failure to achieve the correct angle in TKA procedures can result in failure of the bones and/or the implanted prosthetic joint.

OtisMed marketed the OtisKnee cutting guide as a tool to assist surgeons in making accurate bone cuts specific to individual patients’ anatomy based on magnetic resonance imaging (MRI) performed prior to surgery.

None of OtisMed’s claims regarding the OtisKnee device were evaluated by the FDA before the company used them in advertisements and promotional material.

Between May 2006 and September 2009, OtisMed sold more than 18,000 OtisKnee devices, generating revenue of approximately $27.1 million.

On Ocober. 2, 2008, OtisMed submitted a pre-market notification to the FDA seeking clearance to market the OtisKnee.

The company had not previously sought the FDA’s clearance or approval and had been falsely representing to physicians and other potential purchasers that the product was exempt from such pre-market requirements.

On September 2, 2009, the FDA sent OtisMed a notice that its submission had been denied, noting that the company had failed to demonstrate that the OtisKnee was as safe and effective as other legally marketed devices.

The letter warned OtisMed that distribution of the OtisKnee prior to approval would be an FDCA violation, and indicated the FDA viewed the product as a “significant risk device system,” which is defined as presenting a potential for serious risk to the health, safety or welfare of a subject.

Chi and others at OtisMed received advice from legal and regulatory counsel confirming it would be unlawful for OtisMed to continue distributing the OtisKnee.

Though the board of directors unanimously decided to stop further shipments of the devices, Chi and others at OtisMed were concerned that inconveniencing surgeons planning to use the OtisKnee in scheduled surgeries would exacerbate the negative impact of the FDA letter on the reputation of OtisMed and the device.

Chi directed OtisMed employees to organize a mass shipment of all OtisKnee devices that had been manufactured but had not yet been shipped and suggested ways for the employees to hide the shipments from FDA regulators.

At Chi’s direction, OtisMed shipped approximately 218 OtisKnee guides from California to surgeons throughout the United States, including 16 to surgeons in New Jersey.

Both Chi and OtisMed admitted that Chi ordered the distribution a week after the FDA denied OtisMed’s request for clearance.

The civil settlement resolves allegations arising from the marketing and distribution of the OtisKnee without receiving approval or clearance from the FDA for the device.

The  settlement alleged that in May 2006, OtisMed, through co-promotion activities with Stryker Corporation, began commercially distributing the OtisKnee without having received clearance or approval from the FDA for the device.

Federal officials alleged that OtisMed continued to distribute the device while its application was pending and even after the FDA informed OtisMed that the product could not be lawfully distributed until FDA approved the device.

They also alleged that OtisMed encouraged health care providers to submit claims for MRIs that were not reimbursable because they were not performed for diagnostic use, but rather solely to provide data for the creation of the OtisKnee.

The company will pay approximately $41.2 million, including interest, to resolve its civil liability for submitting false claims to the Medicare, TRICARE, Federal Employees Health Benefits and Medicaid programs.

Of that amount, approximately $41 million will be paid to the federal government.  Medicaid is funded jointly by the states and the federal government and participating Medicaid states will receive approximately $376,700 of the settlement amount.