Structure of Starkey subsidiary Northland at center of embezzlement case

After 35 years of manufacturing hearing aids, Starkey Hearing decided to jump into the retail business in 2005 and bought its first hearing aid store. The tiny store was failing, but Starkey didn't want a competitor to take it over.

Soon, other purchases followed — most for the same reason — and the company's Northland retail subsidiary eventually grew to 270 stores nationwide, most small and operating under the All American Hearing umbrella.

The subsidiary is now central to a federal $20 million embezzlement and fraud case against fired Starkey President Jerry Ruzicka and Scott Nelson, its fired CFO, as well as another former executive and two of their business partners.

A key question, according to court documents, is whether Ruzicka, Nelson and Jeff Longtain (the fired head of Northland who has not been indicted) secretly awarded themselves 51 percent of Northland's stock and then sold their shares back to Starkey for $15 million, all without the knowledge or consent of Starkey owner and CEO Bill Austin.

Ruzicka and Nelson have pleaded not guilty in the case and are refuting all charges. They say Austin knew and approved of the setup.

Starkey — one of the world's largest hearing aid companies and the only one headquartered in the United States — has grown by advancing hearing aid technology and building a network of mostly mom-and-pop stores. Austin said earlier this year that 2015 was the company's best year yet, producing $800 million in sales.

When Northland was formed, it was 100 percent owned by Starkey. But federal documents allege that in 2006, Ruzicka, Nelson and Longtain shifted Northland's assets into a new subsidiary called Northland Hearing Centers. That is when the stock was awarded, leaving Starkey with a 49 percent stake.

According to FBI documents, Nelson told the company's general counsel at the time that the ownership split was requested by Starkey's bank. The bank denies ever asking for a change, according to court documents.

Ruzicka approved all aspects of the change using his signatory power for the company, court documents said. Austin, however, told authorities the power did not extend to a deal of this sort and that he specifically told Ruzicka that he would never let Ruzicka "obtain and operate Northland."

Austin and the government contend that Austin signatures found on Northland documents were forgeries and that Ruzicka and other executives used life insurance policies and other bonuses to reward employees who helped them.

Through attorneys, Ruzicka and Nelson insist Austin approved all Northland transactions. Ruzicka's defense attorney, John Conard, said his client never would have risked losing lucrative pay and pensions worth many millions of dollars just to net a slice of Northland that was worth less than $3 million each after taxes. Ruzicka's pension alone was worth $10 million.

"There is no way Jerry would risk that. And I will tell you, Jerry Ruzicka is simply not a thief," Conard said, adding that the government bases its case on partial documentation and on Austin's say so.

It's unclear how Northland's peculiarities could have escaped Austin's attention for 10 years.

Starkey's audited financial statements would have laid out Northland's ownership structure year after year, say corporate lawyers and attorneys for the defendants. And, according to federal documents, Austin told investigators he heard rumors about the Northland improprieties since 2006 but didn't investigate them until 2015, when he heard from an employee that Ruzicka was forming a new company that would compete with Starkey.

The case is unusual no matter which side is to be believed, said Paul Vaaler, a corporate law professor at the University of Minnesota, who is not involved in the case.

Officers at private companies often create subsidiaries like Northland. But Vaaler pointed to three ways in which Northland was atypical: Starkey didn't keep majority ownership; the executives were given shares in the subsidiary instead of the parent company; and Austin said he was not aware of Northland's setup, despite tax and other legal documents that should have required his input.

The setup would have also caused some logistical issues, said Michael Voves, a corporate attorney with Dorsey and Whitney.

"Typically companies consolidate all their subsidiaries under just one tax return for simplicity's sake," Voves said. "When you have an entity that is only 49 percent owned by the company, then it's not a single-owned company and that means it can't be consolidated."

Austin told the FBI, according to court documents, that during the time of Northland's growth, he had turned his attention to running Starkey's philanthropic foundation. He had trusted Ruzicka to run the Starkey Hearing business and keep him apprised of the issues that needed his attention. As sole director of the company, stock transfers and executive compensation awards would be some of those issues.

Prosecutors allege that Larry Miller — the company's fired human resources head, who also has been indicted — helped hide the scheme from Austin by deleting all Northland items from executive compensation records sent to Austin over the years. That possibility, along with the discovery of allegedly forged Austin signatures, gave rise to the government's case that Austin and Starkey were victims, court documents say.

Still, it's highly unusual for a "founder and dominant owner of a private company like Austin, not to stay actively engaged in managing their company," Vaaler said. Because Starkey has an employee stock-ownership plan, "Bill Austin had a fiduciary duty to ask the tough questions [and] an obligation to bring in expertise in accounting, finance, legal and the like to make sure that his employees' [stock] interests were protected."

Authorities will not say if there will be more Starkey indictments. The government has frozen several investment accounts belonging to former Starkey employees with strong ties to Ruzicka or the Northland transactions. The funds are part of the Northland fraud, court documents say.

Affidavits by FBI agents identify 11 former employees as possible "co-conspirators" for having benefited from the scheme or helping to set up or liquidate Northland Hearing Centers' stock. The affidavits also note that executed search warrants unearthed several e-mails from outside counsel to Starkey executives that seem to suggest that Austin may have been kept in the dark about Northland.

A motions hearing is scheduled for Feb. 22. The judge will announce the start date of the actual trial in the near future.

Dee DePass • 612-673-7725