It’s the kind of story that makes you suck in a deep breath: The SEC alleges that three former executives of Sulzer Medica (later Centerpulse Orthopedics) in 2002 falsified financial reports so the company could get $635 million in loans from a consortium of banks to help fund a $1.1 million product liability settlement involving defective hip and knee prostheses.

It raises all kinds of questions: How did Centerpulse’s outside auditors miss it (the SEC says the company gave the auditors false information)? How did the banks miss it during due diligence?

Those question are unanswered, perhaps because Centerpulse was bought up a year later by Zimmer Holdings. Just before the deal went through, Zimmer announced that the SEC was conducting an informal investigation of Centerpulse’s accounting. The deal was delayed but eventually went through. Zimmer has never said what the SEC found; in its most recent Form 10-K report, it stopped mentioning the investigation altogether.

Why did it take almost five years for the news to come out, and why wasn’t anyone prosecuted or at least sued by a bank or a stockholder? The notion that a group of banks and an outside auditor may have been taken for a ride makes the mind reel. Whatever happened, the only result is that the SEC, five years after the fact, filed a securities law fraud civil suit against three Centerpulse financial executives — two of them who live in Switzerland.

According to the SEC, the accounting fraud — which the SEC says in part created profit where there were losses — took place because Centerpulse was trying to finance a billion-dollar settlement of product liability claims. The litigation involved artificial hips and knees that were contaminated with oil and didn’t “take” inside of patients, requiring new surgery (sometimes with an equally contaminated replacement).

Students of mass tort settlements will remember, however, that the $1.1 billion product liability deal was the second attempt at a settlement. A year earlier, Sulzer/Centerpulse tried to settle the litigation for $780 million. Not only was settlement worth less, but it proposed giving claimants a combination of cash and Centerpulse stock. A plaintiff who had a contaminated hip replaced, for example, was to get $37,500 in cash and a minimum of $20,000 in company stock.

And there were strings attached: the claimants couldn’t sell any stock for six months, and then only up to half of it. Then they’d have to wait another six months to sell any more.

So the hypothetical question is this: if the initial cash/stock deal had gone through, would the claimants have eventually been left holding stock that was worth less or worthless because of fraudulent sales and profit statements? The settlement agreement listed the stock’s value at $5.10 a share. If the company cooked the books in order to get bank loans, would it have cooked them in order to prop up the stock price for the cash/stock settlement? And if it was later discovered that the company was losing money rather than making it, what would the stock have been worth then? Bear Stearns stock, anyone?

As it turned out, some plaintiff lawyers balked at the cash/stock settlement, but not because they had any insight into the company’s allegedly creative bookkeeping practices. They thought the amount was too low and they thought Centerpulse’s Swiss “parent” should kick in. But mostly, they objected a lien the company placed against future earnings in favor of claimants who took the settlement. Plaintiffs were free to opt out and get a jury verdict, but they would have to wait six or eight years until the lien came off in order to collect. When the Sixth Circuit said it doubted the settlement was viable — before it even heard the appeal — the new deal was struck.

After Zimmer later bought Centerpulse for $3.2 billion, the MDL judge noted that anyone who took the cash/stock deal would have seen their shares increase in value. In other words, the first settlement would have been a better deal. But if the Centerpulse financial officers weren’t afraid to falsify statements, and considering that no company might buy another company with a lien against earnings for up to eight years, Centerpulse might not have been bought at all. In light of the SEC lawsuit, the lawyers who opposed the initial settlement in 2001 deal may feel a bit more comfortable with their course of action.