WASHINGTON (Reuters) - Four years ago, two analysts who liked to swap notes on numbers they thought looked odd took a fateful step and tipped off U.S. regulators about a company that one of them had watched for months.

FILE PHOTO - The seal of the U.S. Securities and Exchange Commission hangs on the wall at SEC headquarters in Washington, DC, U.S. on June 24, 2011. REUTERS/Jonathan Ernst/File Photo

Orthofix International NV OFIX.O caught one of the analysts' attention in 2012. The Texas-based medical device maker kept hitting ambitious earnings targets and many analysts had "buy" recommendations for the stock.

But the analyst thought something was off. Its earnings reports showed it was taking longer than usual for the company to get paid by wholesale customers, invoices were piling up and executives struggled to offer a convincing explanation, saying logistical problems at foreign offices were partly to blame.

He spent months tracking quarterly reports and earning calls, and using algorithms to compare Orthofix’s ratios and patterns of sales and inventory turnover with financial data of its peers stored in databases such as Compustat.

“I am always on the lookout for something unusual, either just unusually good and under appreciated, or unusually bad,” the analyst told Reuters. “This one showed up as a company that looked like it had the potential to be unusually bad.”

In the spring of 2013, he e-mailed his spreadsheets to a fellow analyst and a friend of more than a decade, with whom he regularly chatted about companies and sectors.

“The way we work together is one person makes a suggestion and the other person challenges it,” that friend told Reuters.

“It is like a war game.”

Now both men stand to win as much as $2.5 million after Orthofix reached a $8.25 million settlement in January with the Securities and Exchange Commission and several former executives collectively paid $120,000 in penalties to resolve accounting fraud charges.

The award might even be bigger, if the SEC also credits the analysts’ tip for leading to a second civil settlement concerning foreign corrupt practices charges.

The pair declined to be publicly identified, citing concerns that it might jeopardize their current professional relations.

Referring to its January settlement with the SEC, Orthofix spokeswoman Denise Landry said the company had self-reported to the regulator and fully cooperated with the government during the investigation.

“We are pleased these matters are behind us,” she said, declining to comment further.

By entering the SEC whistleblower program the duo showed how outsiders with analytical skills and tools and time to spare can accomplish what is typically done by those with inside access to confidential information.

The program, established in 2011 under the Dodd-Frank financial reform law, aimed to bolster the SEC’s enforcement program by encouraging insiders to report potential fraud.

However, since its inception through Sept. 30, 2016, just over a third of the more than $111 million awarded to whistleblowers went to outsiders such as analysts or short-sellers, according to the SEC.

“Sometimes outsiders have a particular expertise and they are able to independently piece things together that might not be as obvious to those close to the matter,” said Jane Norberg, the head of the SEC’s Office of the Whistleblower.

“CHANNEL STUFFING”

In Orthofix’s case, what the two analysts pieced together suggested that Orthofix was goosing its earnings by “channel stuffing.”

If not disclosed to investors, the practice of flooding distributors with more products than they can use or pay for is illegal. It lets the company smooth earnings by prematurely recognizing revenue, and pushing shortfalls into the future.

As the SEC settlement later showed, Orthofix was sending various implants from its spine division to distributors in Brazil that either lacked regulatory approval, or lacked medical instruments needed to use the implants. It then was recording products that could not be resold as revenue, and also treating some of the price discounts as expenses instead of a revenue reduction, the SEC said.

(Graphic: tmsnrt.rs/2pYNwgY)

Even without such details, the analysts felt they had enough to try the SEC’s program.

Their suspicions turned into near-certainty when in May 2013, Orthofix missed its first quarter earnings targets, reporting a 14 percent year-over-year drop in net sales that sent its share price tumbling 15 percent.

“That was when the light bulb really goes off,” the analyst who first started watching the company said.

By then the two had already contacted Jordan Thomas, an attorney at the law firm Labaton Sucharow, which specializes in class action litigation and also takes on a limited number of whistleblower cases.

The law firm gets paid for its services from a portion of the award, but it does not publicly disclose its share.

A TIP AND A FOLLOW-UP

In June 2013, Thomas submitted a tip to the SEC on his clients’ behalf, promising to follow up with a more detailed submission, records show. To bolster their case the analysts kept picking through the Orthofix’s financial statements, while Labaton’s investigators, led by a former FBI agent, hit the phones and scouted industry message boards looking for former Orthofix employees.

One former employee they found revealed in an interview that in order for them to “make their numbers,” the company sent large orders to distributors, only to have them returned and then reshipped to other customers, according to the updated submission Labaton send to the SEC in August.

The update included the analysts’ estimates by how much Orthofix would need to lower their earnings and sales for 2011 and 2012. Those numbers later turned out to be right in line with what the company ultimately restated in 2014 and 2015.

The SEC still does not know the identities of the two analysts, but it will find out in May, when Thomas submits a claim on their behalf asking the SEC to consider giving them an award for their tip.

The analysts, who live in different cities, said that the day the SEC charged Orthofix, they were just too far apart to get together and celebrate, but that an award would justify the trip.

“If and when the actual award settlement is disclosed, then we can meet up for champagne,” one said.