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Freedom Holding: The Red Flag Factory in Belize

Freedom Holding Corp. has some explaining to do.

The financial services firm has quite improbably become one of the fastest growing companies on the planet. It lists its shares on the Nasdaq, is incorporated in Las Vegas, but for all intents and purposes runs its operations mostly in Kazakhstan.

As a December investigation by the Foundation for Financial Journalism showed, Freedom Holding’s ballooning profits have resulted from baffling and opaque business practices that its management is not keen to discuss.

Among the arrangements is Freedom Holding’s close connection to FFIN Brokerage Services, a Belize-based securities trading firm owned by Timur Turlov. He also is Freedom Holding’s billionaire founder and majority shareholder.

Even the most seasoned investor has probably not witnessed related-party transactions of the scope of FFIN’s dealings with Freedom Holding.

Last year more than 56 percent of Freedom Holding’s revenue came from FFIN commission payments, and in 2019 they represented over 65 percent. What Freedom Holding does to earn the commissions is not readily apparent, however. Yet the two companies are so intertwined – Freedom Holding’s senior managers use FFIN email accounts – it’s not clear the two companies are separate in any real sense.

In June, Freedom Holding for the first time disclosed in its annual report its relationship with FFIN, categorizing this as a risk factor for investors to weigh before buying shares. Highlighted as a matter of particular interest: the portion of revenue that Freedom Holding received from Turlov’s company. In the annual report, Freedom Holding’s auditor, Salt Lake City’s WSRP LLC, acknowledged the FFIN connection as part of several “critical audit matters.” (Engaged by Freedom Holding to assess the accuracy of its accounting, WSRP did not weigh in on the propriety of Freedom Holding’s FFIN relationship.)

But FFIN’s own annual report, also released in June, ought to give Freedom Holding investors pause: In just a year, FFIN’s assets grew almost 1,100 percent, to more than $2.5 billion. That’s significantly larger than Freedom Holding’s $2 billion in assets.

Were FFIN ever to hit dire financial straits, Freedom Holding could be in real trouble.

And FFIN’s profits have put substantial cash in Turlov’s pockets: $12.8 million in 2019 and more than $30 million last year. (Although FFIN recorded a $16 million loss last year, Freedom Holding’s outside legal advisor Ron Poulton of Salt Lake City explained that no actual loss occurred. The $46.53 million in impaired trade receivables recorded by FFIN were not losses resulting from clients failing to pay but an “accounting convention” to document a charge like a noncash expense such as depreciation, he said.)

Keeping terms of a relationship under wraps

While the specifics of FFIN and Freedom Holding’s arrangement have not been publicly disclosed, the basic contours are clear: FFIN acts as a broker for Freedom Holding, primarily executing trades in popular U.S. exchange-listed equities and initial public offerings.

Peddling IPOs is Freedom Holding’s most aggressively promoted line of business, and FFIN handles the firm’s IPO-related customer service issues. For its part, FFIN has a distinctive business practice: requiring clients to observe a 93-day lockup period for any IPO shares they purchase. Customers cannot sell or even transfer to an outside account the newly purchased shares for that three month period.

This is starkly at odds with the typical U.S. and European brokerage practice, whereby clients are free to trade their shares immediately after receiving an allocation. Any other brokerage that tried to impose this constraint would likely be assured of an immediate customer exodus and a wave of litigation.

The Foundation for Financial Journalism asked Poulton several questions about the particulars of the Freedom Holding-FFIN relationship. (Poulton addressed one group of questions but refused to answer a second, more specific set.) He would speak only generally about FFIN, saying, “The functional purpose of FFIN Brokerage Services to its clients are diverse and private to them.”

Poulton also cited changes in Russian and Kazakh laws that might reduce Freedom Holding’s reliance on FFIN. Turlov set up FFIN in 2014 to offer Russian and Kazakh residents access to U.S. dollar-denominated investments, Poulton said. At the time, Russian regulators frowned on individuals owning British pound- and U.S. dollar-denominated investments. In 2018, however, the two countries started to ease such regulations.

The Foundation for Financial Journalism posed the same questions to Adam Cook, Freedom Holding’s corporate secretary; Askar Tashtitov, Freedom Holding’s president; and Turlov but did not receive a reply.

Generating huge profits via a small Cyprus unit

Notwithstanding the steady skyward march of Freedom Holding’s share price, its financial statements are surely catnip for short sellers and financial skeptics.

Embedded in the filings is the prominent role Freedom Holding’s Cyprus unit plays in the company’s growth. That subsidiary, which used to be the prime component of Freedom Finance Europe Limited, has been formally renamed Freedom Finance Europe Limited; the unit opened in 2017 and its main task is operating Freedom 24, an electronic trading system.

As described in the December article, the Cyprus subsidiary’s defining feature is achieving astronomical profit growth, unrivaled on Wall Street. Although in 2017 the Cyprus unit reported a $30,000 loss, by 2019 it had $33.8 million in earnings. In 2020, the subsidiary’s income rose to $80.4 million.

Freedom Holding’s earnings growth story is entirely a function of its Cyprus subsidiary. One way to track this is to compare the published financial results for both Freedom Holding and its Cyprus subsidiary from Jan. 1, 2020, through Dec. 31, 2020. (The Cyprus unit files a risk disclosure statement once a year that includes its annual net income, but corporate parent Freedom Holding releases its income quarterly and its fiscal year ends on March 31.)

For the nine months that ended Dec. 31, 2020, Freedom Holding reported $90.1 million in net income, with $80.4 million of this derived from the Cyprus subsidiary.

Thus, for nine months of Freedom Holding’s most recent fiscal year, the Cyprus unit contributed at least 56 percent of the parent company’s $142.9 million in net income.

And according to a recent regulatory filing, the Cyprus subsidiary achieved those results with minimal resources. Making that sum of money took only 13 employees and $6.3 million in capital.

Taken at face value, the Cyprus unit’s gaudy performance likely catapults it to the top of the list of the most profitable trading desks in history. (The distant second: Michael Milken’s high-yield trading operation at Drexel Burnham Lambert, which in 1987 generated a purported $2 billion in revenue, with Milken pocketing an estimated $550 million.)

To an outside observer, the fact that the Cyprus unit could generate profits at this scale is baffling. After all, it is a no-frills online trading operation that facilitates individual investors’ stock trades. It definitely is not an elite proprietary trading division; compensation for its 13 employees last year totaled less than $1.3 million.

Carrying out trades in a circuitous fashion

Freedom Holding employs a remarkably circuitous order execution process for its customer’s trades. It is labyrinth to a degree that suggests that obtaining the best possible price for the client is a secondary concern.

A transaction might look something like this, according to conversations with current and former Freedom Holding clients, as well as a former company executive: A client of Freedom Holding who attempts to buy shares online is promptly directed outside its platform to FFIN, which then routes the order to Freedom Finance Europe in Cyprus. But final execution of the client’s order appears to require another handoff, either to a Freedom Holding subsidiary in Moscow or (frequently) to a firm with a troubling regulatory history, Lek Securities U.K. Limited in London.

One possible reason for this complexity? Fee layering, the practice of charging a client multiple fees on a single transaction.

Layering is a legal, albeit controversial, practice that has fallen out of favor in the U.S. money management industry, given the rise of lower-cost index and exchange-traded fund investing. But for Turlov and his colleagues, elongating a trade’s life cycle in order to collect two or three sets of fees might be tempting since their largely Russian and Kazakh client base might have scant experience with Wall Street practices or robust consumer advocacy.

A further puzzle: The Cyprus unit’s 2020 risk disclosure statement noted that last year FFIN executed 24 percent of the trades made by the unit, up from 9 percent in 2019. This is odd since neither FFIN nor the Cyprus subsidiary hold any U.S. brokerage licenses.

Doing business with companies of questionable repute

One of the nicer things about managing an expanding and profitable company is having options. For example, if a customer poses a reputation risk or is too demanding relative to his or her economic value, ending the relationship is generally a low-risk proposition.

Timur Turlov and his managers do not seem to hold this view, however, because they have regularly done business with people and companies whose extensive legal problems would cause most U.S.-based managers to stop in their tracks.

Consider FFIN’s business relationship with two Moscow-based companies: asset manager QBF LLC and network marketer CityLife.

Both QBF and CityLife have attracted the scrutiny of the Russian government: The Ministry of Internal Affairs raided QBF on May 31 and arrested two of its principals for purportedly conducting a Ponzi scheme. And on June 1, the Central Bank of Russia’s Unfair Trade Practices unit added CityLife to a list of companies with identified signs of illegal activity for allegedly showing signs of running a pyramid scheme.

How does FFIN fit into all this? According to a translation of a Russian language press account of the Interior Ministry’s QBF raid, FFIN was one of several banks and brokerages the asset manager­­­’s executives were said to have used to move investor cash out of Russia. (Neither Turlov nor Freedom Holding were named in the article.)

While using a Russian language search engine, the Foundation for Financial Journalism found a CityLife co-founder’s FFIN wire instructions designating 16 separate bank accounts that were to receive funds. It is not clear who posted such a sensitive document online, but the root link is from a CityLife website. One of the banks listed on the form is Freedom Holding’s Bank Freedom Finance LLC.

Questioned about FFIN’s relationship with QBF and CityLife, Poulton confirmed that the two firms “at one time did have standard client brokerage accounts with FFIN Brokerage Services.” He said that FFIN closed the QBF account “in the fall of 2018” but did not provide a reason.

Poulton added that the CityLife account was opened in early 2021 and “conducted modest trading” and when the Central Bank of Russia added it to its list of companies with identified signs of illegal activity, FFIN closed the account.

Update: This story was updated on Aug. 8, 2021, to  clarify the relationship of the Cyprus unit to Freedom Holding’s Freedom Finance Europe; it used to be referred to as its subsidiary but now is simply called Freedom Finance Europe.




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Danny Guy, Derrick Snowdy and the Strange Wars of Confused Men

Derrick Snowdy is probably as close to a celebrity as Canada’s private investigator community has.

Starting in 2010, Snowdy burst into view as a prime mover in the political controversy colloquially known as “the busty hookers’ scandal.”

Snowdy proved to be a quick study at capturing an audience’s attention, ever ready to regale listeners with some of the inside stories from his investigations.

So when Catalyst Capital founder Newton Glassman brought a stemwinder of a defamation litigation in 2017 against a host of hedge fund managers and journalists, it was not surprising to see Snowdy involved.

(Foundation for Financial Journalism readers will recall our two 2018 investigations that looked into the quality of disclosures at Callidus Capital and Catalyst Capital, the two investment vehicles Glassman controlled. In July 2019 Catalyst amended the initial defamation claim to add Bruce Livesey, the article’s co-author, as a defendant.)

After all, given the numerous well-heeled defendants — and their lawyers, many sporting big litigation budgets — the prospects for an investigator with a knack for digging into corporate fraud seemed attractive.

There was just one thing.

A series of filings were unsealed late last week in Catalyst’s litigation revealed that Snowdy had indeed been hard at work on these types of issues for several years. (The filings were made by West Face Capital and the other defendants.)

But it had been for the other side.

So who bankrolled Snowdy’s efforts? A single client: Danny Guy, a veteran Canadian money manager and the general partner of Harrington Global Opportunities Fund.

Meet Danny Guy

Little about the arc of Daniel Gerrison Guy’s career in finance would imply a disposition towards garish conspiracy theories.

After starting in brokerage research in 1993, Guy joined Banfield Investment Management, a then prominent Toronto risk arbitrage fund in the late 1990’s. In 2001, Guy led a buyout of the fund and renamed it Salida Capital. Becoming Salida’s chief investment officer, Guy changed the fund’s investment strategy to a more directional, commodities oriented focus with a heavy emphasis on private equity.

(Salida is Spanish for “exit,” a commonly used term in private equity that means an investment was successfully concluded via a fund either selling an asset at a higher price or to the public through an initial public offering.)

From 2002 through 2007, Salida posted very handsome returns, but in 2008, the one-two punch of the global financial crisis and the collapse of Lehman Brothers, the fund’s prime broker, led to disastrous losses. Though Salida’s performance in 2009 and 2010 was stellar, restoring the fund’s assets under management proved much more difficult, and in 2013 it began to shutter its portfolios.

In 2011 Guy moved to Bermuda, but it is unclear when the Luxembourg-domiciled Harrington Global was formally launched, or if it has limited partners. The fund does not appear to report to hedge fund industry databases.

Snowdy told the Foundation for Financial Journalism that his connection with Guy began when Salida Capital’s then CFO asked him to perform some due diligence on an investment Salida had made that the fund was concerned about.

“It was to look at a company called StarClub. I did some work and determined it was pretty much a fraud,” he said. (StarClub’s product was a software application that purported to help so-called social media influencers track the reach and impact of their endorsements.)

Snowdy continued that he delivered a report and forgot about it until November 2016 when Salida’s CFO called him and said, ” ‘It looks like you were really right on [StarClub] and asked me if I could I help them build a case for a lawsuit.’ ”

Snowdy said in the course of investigating StarClub in 2016 he wore a hidden recording device while posing as a potential investor during a meeting at Goldman Sachs’ headquarters, and he identified and obtained photos of a yacht that StarClub’s founder Bernhard Fritsch allegedly owned. The FBI knew about and approved everything he did, Snowdy said.

In August 2017 federal prosecutors in Los Angeles unsealed an indictment that charged Fritsch with a series of fraud-related counts. The case is scheduled to go to trial in January 2022.

According to the indictment, Guy invested more than $22.4 million of Salida and Harrington Global’s capital in StarClub.

The road to vengeance

Guy’s experience with a pharmaceutical concern called Concordia Healthcare is why he became consumed by the idea of exposing how short sellers operate.

Concordia was a once high-flying company in which Harrington Global had a 2.7 million share stake, at one point amounting to over 5.2 percent of its shares outstanding.

Concordia’s business model was similar to that of Valeant Pharmaceuticals International, in that it used aggressive borrowing to fund purchases of established drugs. The goal was to simultaneously raise drug prices while avoiding costly (and recurring) research and development expenses.

It was a model that worked for a little while.

Unfortunately for both Concordia and Guy, when presidential candidate Hillary Clinton sent out a 21 word tweet on September 21, 2015, everything changed.

Clinton’s retweet of a New York Times article about a series of astronomical price hikes in a drug called Daraprim brought the issue of drug prices front and center in the 2016 presidential race.

And much of that ensuing dialogue centered on how constant drug price increases were forcing brutal sacrifices and trade-offs for many American families.

Congressional hearings soon followed.

A month later Valeant Pharmaceuticals came in for its own reckoning: On October 15 the Foundation for Financial Journalism exposed how the company’s Philidor subsidiary helped it keep certain drug prices artificially high, as well as evade pharmacy ownership regulations.

Concordia, with about $4 billion in debt and reliant on acquisitions to fund the revenue growth investors were demanding, was suddenly hamstrung in its ability to boost prices.

With a business model whose future had suddenly become an open question, Concordia’s share price soon began to slide. Moreover, it attracted numerous short sellers, including Marc Cohodes, an ex-hedge fund manager who uses his twitter account to offer unfiltered, often profane takes on companies he is short.

Starting in October 2015 Cohodes began building a short position in Concordia’s shares. In June 2016 company CEO Mark Thompson sued Cohodes for defamation; Cohodes happily fired back with lengthy letters to U.S. and Canadian regulators in July and August enumerating several ways he thought the company was misleading investors.

In August, six weeks after suing Cohodes, Thompson was subject to a humiliating  margin call, and two months later he quietly resigned. He withdrew his suit against Cohodes soon after.

Cohodes, asked for comment about Concordia, said he was happy to have shorted it, “in the $70 range,” but declined to elaborate more on the experience, beyond noting tersely, “[Concordia] was a piece of shit.”

(A word of disclosure: In 2017 Cohodes made a donation of $344,593.20 to the  Foundation for Financial Journalism. He is discussed further below.)

Guy approached Canadian securities regulators in 2016 to allege that short sellers were depressing Concordia’s share price through illegal trading tactics such as “spoofing” in order to trigger a wave of algorithmic selling. No regulatory action was taken.

Concordia sought protection from creditors in October 2017, and Harrington Global liquidated its Concordia position at an approximately $150 million loss. (After reorganization, the company is now known as Advanz Pharma Corp.)

Sustaining such brutal losses galvanized Guy’s thinking about Concordia’s demise: A cabal of short sellers spread disinformation about the company’s prospects while using illegal trading tactics to pressure its share price.

Central to proving this claim, Guy felt, was obtaining the identities of those responsible for perpetrating the “short-and-distort” campaign on Concordia. His attempts to get the information through hearings with regulators failed because of concerns over privacy.

To that end, Harrington Global petitioned for a Norwich Order — a motion delivered on a third-party in possession of material information — that would have compelled Canada’s brokerage regulator, the Investment Regulatory Organization of Canada, to disclose those names.

But Harrington Global’s request was denied in a 2018 Ontario Superior Court ruling.

In January Harrington Global sued a series of U.S. and Canadian banks in the U.S. District Court for the Southern District of New York. The claim primarily alleges that traders at large banks used illegal tactics that served to manipulate Concordia’s price downward.

Asked about Guy’s views on Concordia’s collapse, Snowdy assessment was blunt.

“I told Danny that [Concordia CEO] Mark Thompson was a lying sack of shit,” Snowdy said.

But, Snowdy continued, “Danny defended Mark Thompson. And then [Guy] would start screaming about naked short sales, Marc Cohodes’ role in all this, and that crap. I told him that [Cohodes] was right about Concordia.”

In a long, rambling letter to West Face’s lawyers in which Snowdy discusses his role in the Catalyst case, he said that his take on Concordia’s collapse antagonized Guy a great deal. On one occasion, when Snowdy was vacationing with his kids in the Bahamas, Guy accused him of being there to only to make secret financial arrangements — the implication being that Snowdy would only have said that because short sellers paid him off.

This darker turn in Guy’s worldview was on display in an April 2018 email to the Ontario Securities Commission. After Guy saw that Greg Boland, West Face Capital’s general partner, looked at his LinkedIn profile, Guy wrote an a threatening email to several OSC attorneys that promised “a fucking war” if short sellers targeted other companies he was invested in, or if anything happened to his family.

[Guy was not the only one being paranoid. In a phone interview, Snowdy related how in 2018, en route to a meeting with Nate Anderson — also a defendant in the Catalyst case — he detected two people following him. This led him to believe that perhaps Anderson’s office had been somehow compromised. Anderson said that in that period his office was at a WeWork, and he didn’t think that being infiltrated by private investigators was a very big risk.]

The Foundation for Financial Journalism repeatedly sought to interview Guy. His conditions — fly to Bermuda and interview him — proved unworkable. In a response to a text message about his opposition to short selling, Guy said, “I have no problem with shorting when it’s done right.”

Penetrating the wolfpack

There was nothing terribly complex about what Snowdy did.

Starting in 2017, Snowdy began posing as a sympathetic, knowledgeable fraud-fighting ally to many of the reporters and short sellers named in the Catalyst claim. More importantly, Snowdy leveraged this nascent rapport to obtain introductions to other investors and forensic analysts who were researching and shorting publicly traded companies.

A big part of Snowdy’s operating methodology was taping phone calls, according to emails he sent; one of his two phone numbers was set to automatically record and was stored on his home computer. That may pose a prospectively large legal headache for him since he described recording California resident Marc Cohodes, and the state’s  laws require both parties to consent to having a call recorded. (Cohodes strongly denied having given his consent for recording.)

The unsealed documents, however, do not specify what information he got from taping Cohodes. When asked about taping Cohodes and the absence of his consent, Snowdy did not reply.

In a recently unsealed, multi-month WhatsApp message exchange between Guy and Glassman, Guy called this strategy “penetrating the wolfpack.” This echoes the theme Guy began enunciating with his angry email to the OSC: Short sellers are dangerous people.

Simultaneously, Snowdy was providing what he overheard — the gossip, the sources, targets and methods – to a small group of corporate executives who felt short sellers were unfairly (or illegally) attacking their companies.

The pay for doing these infiltrations was at least decent.

According to a memorandum of an August 2017 meeting between Snowdy and private investigators working for Catalyst and its lawyers, Guy paid Snowdy $25,000 per month and covered his expenses.

What Snowdy found

What Snowdy told people he uncovered, according to the court filings, looks very much like a version of a common short selling conspiracy trope. It usually follows along these lines: A loose network of short sellers — taking their cue from one individual leader — manipulate the press with misleading information, and then game the greedy or incompetent prime brokerage units at investment banks to allow them to flood the market with improperly borrowed stock. The result is a rapidly sinking share price for any company targeted.

Elements of this idea have been around for decades, but it was not until former CEO Patrick Byrne, during a 2005 presentation he called “The Miscreant’s Ball,” that these disparate complaints about reportorial malfeasance and short selling perfidy were housed in a unified theory.

Byrne claimed a Sith Lord — later revealed to be former Drexel Burnham Lambert executive Michael Milken — was then orchestrating (somehow) much of the dubious short selling activity to his benefit. He also argued that a large group of business journalists were merely transcriptionists for short sellers, and that the miscreants preferred to wage their campaigns in groups.

Snowdy, during a September 2017 meeting where he presented his findings to Jim Riley, former Catalyst COO and general counsel and others, leveled allegations that seemed to check many of the same boxes Byrne had complained about.

There are “puppet masters” that control the network and their connections to shadowy foreign capital, as well as a slew of seemingly nefarious linkages between everyone he named. And for good measure, Snowdy touched upon regulatory capture, a favorite theory of Byrne’s, when he appeared to suggest short sellers had somehow neutralized the Ontario Securities Commission.

For his part, Guy seems to agree with Deep Capture.

Guy sent Glassman a link, and told him that the article will “make your head spin.” (Snowdy, speaking about Guy’s support for Deep Capture in a meeting with Catalyst’s lawyers in September 2017, said that he felt that 25 percent of it was so untrue it calls into question the balance of the work.)

And it ought to be recalled that making these types of allegations can have consequences, especially in Canada, where libel and defamation laws favor the plaintiff.

In 2008,’s Byrne and his then colleague Mark Mitchell published “Deep Capture,” a conspiratorially virulent expansion upon Byrne’s “Miscreant’s Ball” thesis. Altaf Nazerali, an occasional small cap stock promoter depicted in Deep Capture as an international terror finance operative, sued for libel in British Columbia’s Supreme Court. After a lengthy and expensive trial, Byrne, Mitchell and the other defendants lost the case, and in a scathing judgment, were ordered to pay $1.2 million dollars in damages.

Wearing a wire 

One company that appears to have placed great stock in Snowdy’s information is MiMedx Group, an Alpharetta, Georgia-based manufacturer of skin graft and wound care products.

MiMedx filed suit in October 2017 against a series of short sellers, claiming the company had been libeled and that its business prospects were interfered with. A month later, Parker “Pete” Petit, MiMedx’s outspoken founder and CEO, began making public remarks about short selling that were nearly identical to Guy’s.

Petit focused particular ire on Marc Cohodes, accusing him in an October 13, 2017, post on the company’s website of being the ringleader of a short seller “circus” and spreading misinformation. This was baffling in that, as Cohodes put it, “I had never heard of the company until that moment.” (Cohodes also won the fight against MiMedx’s management: On February 23, Petit was sentenced to one year in prison; the COO received the same sentence.)

To get more information on Cohodes and other short sellers, MiMedx’s outside law firm, Wargo French, hired Snowdy. (David Pernini, the firm’s Atlanta-based partner that directed Snowdy’s engagement, did not return a phone call seeking comment.)

Snowdy confirmed that he had worked in 2018 for MiMedx, but that it was not a standard engagement for him. He said that he was doing so within the context of “working undercover” for an unspecified federal agency.

“Any email or report I wrote for [Wargo French] was scripted” by this federal agency, said Snowdy.

Pressed on the identity of this purported agency over several weeks, Snowdy would only say this organization’s mission is, “criminal justice, with the power to arrest people.”

Asked how much MiMedx paid him to report on Marc Cohodes and other investors critical of the company, Snowdy said he didn’t get a dime. When Snowdy was asked why he would work for free, and if that triggered any suspicions at MiMedx, he declined to comment.

Incredibly, this story gets even more unusual, with Snowdy alluding to “settlement terms” in the U.S. and Canada that prevented him from discussing his MiMedx activities.

A call to the FBI seeking comment was not returned.

Vincent Hanna dials in

Guy initiated contact with Glassman on August 11, 2017, via email, and using the pseudonym “Vincent Hanna,” a character portrayed by Al Pacino in the 1995 movie “Heat.”

(In a strange aside, Snowdy, in his letter to West Face’s lawyers, recounted meeting a pair of individuals in a New York office lobby in early 2018 who introduced themselves as “Vincent Hanna” and “Neil McCauley,” the name of the movie’s Robert DeNiro character.)

While Guy used a pseudonym for an additional 12 days, he wasted little time in telling Glassman the names of short sellers he suspected were involved with Callidus Capital’s stock. Ironically, given Snowdy’s role, as well as Catalyst’s extensive use of Black Cube, Guy warned Glassman that private investigators were likely tailing him and that Russian hackers could be trying to disrupt his fund’s operations.

(There has been no suggestion Guy or Snowdy had anything to do with Black Cube’s operations; Snowdy, in remarks to the Foundation for Financial Journalism, said that he believed he was a target of Black Cube too.)

In notes from an August 23, 2017, conference call with Catalyst executives and lawyer’s, Guy — still using the “Vincent Hanna” moniker — continued to frame his objection to short selling along familiar lines: Arguing Concordia was “a dry run” for taking down the much larger Valeant Pharmaceuticals, making allegations of possible Russian and Hong Kong money laundering, speculating about organized crime money at work shorting stocks, and Marc Cohodes.

Glassman was not a fan of Snowdy

The unsealed documents show Catalyst executives and lawyers eagerly anticipating Snowdy’s research, and they afforded him three separate opportunities to present his findings.

But when Snowdy could not — or would not — produce the desired recordings and emails that Guy had assured them his investigator possessed, Glassman became a vehement critic.

Glassman, quoting his lawyer after one meeting with Snowdy, said he provided, “Two and a half hours of interesting but unusable bullshit — and two and a half minutes of food for thought.”

And Glassman appeared especially angry at Guy’s inability to force Snowdy to produce them since any of his work product would belong to Guy as the client.

“Right now [Snowdy] is using u and hurting u badly. U clearly r too stupid or blind to see it,” wrote Glassman.

Snowdy’s evidence, “was less valuable than what my dog’s left for me on my lawn this [morning.]”

All those documents? None of them are real

For six weeks the Foundation for Financial Journalism has been in frequent contact with Snowdy about his work for Danny Guy. Questions begat more questions and Snowdy’s response has never wavered.

He insists that almost none of it happened.

In other words, Snowdy did not work on behalf of Danny Guy to infiltrate any networks, and has not spoken to Danny Guy since “sometime in 2016.”

The Foundation for Financial Journalism showed Snowdy emails between himself and Guy discussing his assignment in April 2018, naming certain reporters and short sellers of interest to Guy and Catalyst.

“Forgeries,” he speculated in a phone interview. “But I can’t really be sure. You would be amazed at the shit I’ve seen go down up here in terms of corruption.” (He was entirely indifferent to a reporter’s speculation that no one would believe a word of what he said.)

What about Snowdy’s prominence in numerous documents written by Glassman’s own lawyers, which a judge – as part of a broader 55 page rulingordered submitted into discovery? Snowdy told the Foundation for Financial Journalism that he did not care to speculate “who got what wrong, or why.”

Snowdy did admit being at the meetings with Catalyst’s Jim Riley and the firm’s outside lawyers, but said he primarily discussed whether Catalyst had a role in some hacking attempts he had discerned on his own smartphone and computers.

Not so strong on the facts

There is a chasm between what Snowdy reported to Guy, Catalyst’s lawyers and investigators, and what can be objectively verified.

Snowdy said that he had worked with Carson Block on his Sino-Forest short and was an attendee at a Christmas party he threw. Block, however, said Snowdy had nothing to do with Sino-Forest — which he shorted in 2011, and which filed for bankruptcy protection in 2012 — and that apart from one breakfast with him in 2015 in San Francisco, he has never met him again.

[In disclosure: In 2020 Carson Block donated $5,000 to the Foundation for Financial Journalism.]

“Over the years, maybe from 2016 to 2018, we used [Snowdy] to help us track down documents on a handful of Canadian marijuana companies [Muddy Waters Capital] was considering shorting. I’m confident that we didn’t pay him over $10,000,” said Block. “And it’s been awhile since the fund worked with him, I can tell you that.”

Snowdy claimed Cohodes asked him to short stocks along side him, that he was invited to stay at his house, and, as “a loyalty test,” that he had been left alone with his son Max, Cohodes’ 33-year-old son with cerebral palsy. Nothing close to that happened.

“My God what bullshit,” said Cohodes.

“None of that happened. The part with Max is maybe the most insulting,” he said.

More stuff that Cohodes said didn’t happen: Having offshore bank accounts — something he denies in full throat — and using Anson Funds (a Canadian money manager named in the litigation) to manage his money.

“I don’t need help from [Anson] to make money,” Cohodes said.

The truth of the matter, according to Cohodes, is that Snowdy came to his house once for lunch. When he traveled to Toronto for business on several occasions, Cohodes said Snowdy drove him around.

For all that, Cohodes said he had been dragged into this controversy despite never having shorted a share of Callidus’ stock.

A personal disclosure and a mea culpa

One thing Snowdy was at least partially correct on: The introduction to Cohodes, an obvious ticket into the broader short seller community — came from me.

So some first person disclosure is called for.

First off: How did I get introduced to Snowdy? Carson Block.

According to Block, in early 2015 Snowdy contacted him out of the blue and pitched him on a story on Canadian Rail. He passed on it but suggested to Snowdy I might find aspects of the story compelling from a journalism standpoint. Block and I spoke briefly about why he passed on the story at the time and have never again discussed the issue.

I shelved the story for months. Later in the year I re-examined the parts of it that I found interesting, and in 2016 I began to report it. As part of that I reached out to Snowdy — there had been no contact between us since the year before — and he agreed to put me in contact with a man he said was his client. The client had a large cache of Canadian Rail documents that emerged from a litigation he was then involved in.

His client wanted to interact in person so I flew to Toronto. Snowdy picked me up and drove me to his client. We had a few meals in transit, and on two of the four days I was in the area, Snowdy gave me a lift to his client, and he discussed with amusement a judge’s attempt to prevent him from speaking about Canadian Rail. The story I wrote in December 2016 was almost entirely informed by my work in those documents.

It turns out Snowdy lied to me about his legal trouble in that case, having received a restraining order in 2014, according to the recently unsealed documents. (I recall looking for a mention of him in the court record and not finding any, but the ruling may have been sealed at the time or attached to a motion I overlooked.)

While driving with Snowdy, he repeatedly discussed his skepticism of Concordia and Home Capital Group, a then troubled mortgage issuer Cohodes was publicly critical of. Snowdy asked me for an introduction to Cohodes. I agreed, sent an email introducing them, and never thought of it again.

What emerged afterwards is personally and professionally horrifying: Cohodes took my word that Snowdy seemed like a regular, well intentioned guy; he proved to be the very opposite of that. Over the course of a few years Snowdy used Cohodes’s name to come into his own house, meet numerous investors and it is a fair bet that any number of the people Snowdy met through Cohodes were surveilled, recorded, and through no fault of their own, may yet have some legal headaches.

Worse, with a connection to Cohodes established, Snowdy eventually got work surveilling him from MiMedx, a company that took fighting short sellers to a new level. The campaign initiated by the company’s ex-CEO was so ugly that even baseless money laundering accusations became forgettable after he leveraged his political connections to a Senator who requested that the FBI visit Cohodes’ house and warn him about a threatening tweet.

And all from my brief email introduction. It is a mistake I deeply regret.






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For Jazz Pharmaceuticals, Failure Is the New Winning

In late June, Jazz Pharmaceuticals began to market a drug aimed at treating people whose metastatic small cell lung cancer has not responded to an initial round of chemotherapy.

The drug, lurbinectedin, was developed by Madrid-based PharmaMar S.A., which in December 2019 signed a licensing agreement with Jazz. This permitted Jazz to sell the drug in the United States under the brand name Zepzelca. (Lurbinectedin had failed a clinical trial for ovarian cancer in 2018.) Dublin-based Jazz, with its shares listed on the Nasdaq, has significant U.S. operations in Philadelphia and Palo Alto, California.

For U.S. oncologists who treat individuals with small cell lung cancer, lurbinectedin’s arrival was a big deal. Dr. H. Jack West recalled his cautious optimism upon reading of lurbinectedin’s initial clinical trial results last June, especially since few therapies existed for people with small cell lung cancer.

An associate clinical professor in medical oncology at City of Hope’s department of medical oncology and therapeutics research in Duarte, California, West told the Foundation for Financial Journalism that lurbinectedin’s “results in Phase II were [notable] because it was a decent-sized trial [of 105 people] and the drug seemed to have a measurable effect on a subset of patients.”

The meager number of small cell cancer drugs in the development pipeline has led some oncologists to desperately embrace any treatment showing even modest promise, said West, who added that he has seen doctors “cheerleading” for pharmaceutical companies with products in trials and forgoing skepticism about existing treatments.

Despite the fact that Zepzelca was on the market for only six months of last year, it generated 4 percent of Jazz’s 2020 revenue, or $90.4 million. Jazz’s investors apparently loved the earnings boost from lurbinectedin sales; the company’s market capitalization climbed by more than $1.7 billion.

But the Food and Drug Administration has permitted lurbinectedin’s sale in the United States only under its accelerated approval program. The FDA required that PharmaMar conduct a confirmatory trial to prove the drug’s clinical benefit before seeking full approval.

PharmaMar had initially proposed in December 2018 that Phase III of lurbinectedin’s clinical trial serve as its confirmatory trial; the FDA granted this request in June 2020. (The FDA requests confirmatory trials only for accelerated approval program drugs.)

Yet by Dec. 3, Jazz and PharmaMar disclosed that lurbinectedin had failed to meet the primary endpoint of its clinical trial’s Phase III: achieving improvement in the overall survival of participants. The medication did not succeed in proving its benefit to study participants over the standard of care offered by already approved treatments for small cell lung cancer.

The FDA, however, did not pull the drug off the market. This lack of a response is becoming commonplace: The agency has permitted many drugs in the accelerated approval program to remain commercially available after their Phase III clinical trial failures.

Tackling daunting hurdles

While many cancers are lethal, and cancer treatments are generally complex and expensive, small cell lung cancer poses a special challenge.

Named after the cancer cell’s size and shape when viewed through a microscope, small cell lung cancer will cause about 13 percent of the 235,760 newly diagnosed cases of lung cancer in the United States this year, the American Society of Clinical Oncology has projected. Compared with the wealth of information known about other cancers, relatively little is understood about how small cell lung cancer metastasizes. The tumors typically develop in air passages around the windpipe — especially in older smokers — and rapidly spread to other organs. This happens so quickly that almost 70 percent of individuals with the disease have experienced metastasis by the time of their first diagnosis. Chemotherapy might later appear to have eradicated tumors, only to have them grow back.

Just 6 percent of people diagnosed with metastatic small cell lung cancer live five more years, according to the American Society of Clinical Oncology. In comparison, 13 percent of people diagnosed with metastatic pancreatic cancer reach that milestone.

Pharmaceutical companies such as AbbVie, Poniard Pharmaceuticals and United Therapeutics have poured billions of dollars into the development of drugs for small cell lung cancer and clinical trials, but few life-extending options have materialized over the past three decades. All told, 40 clinical trials for small cell lung cancer treatments have failed.

Failing scientifically, yet scoring commercially

Traditionally, the FDA has viewed a drug’s inability to outperform current treatments in extending or improving the life of study participants as disqualifying — except for medications in its accelerated approval program, such as lurbinectedin. And lurbinectedin, like many cancer drugs, has documented side effects including fatigue, nausea and declines in white blood cell counts.

Commercially, though, lurbinectedin has been far from a failure, and brokerage analysts have projected that Jazz could take in $200 million to $225 million in revenue this year from sales of the drug. One Wells Fargo analyst, in a June 2020 research note went so far as to suggest that Zepzelca’s annual sales might peak at $700 million. PharmaMar is benefitting handsomely, too: Jazz’s annual report noted the $300 million in payments it made to PharmaMar last year.

And the actions of Jazz stand in sharp contrast with those of larger rivals with oncology drugs.  After Bristol Myers Squibb and Merck recently disclosed the failure of confirmatory trials for their own bestselling drugs under accelerated FDA approval for treatment of small cell lung cancer, both companies immediately stopped marketing them for that purpose and removed the indication from their labels. Bristol Myers Squibb’s Opdivo and Merck’s Keytruda are still indicated for the treatment of other cancers, including non-small cell lung cancer, though.

The FDA is rather vague about what is supposed to happen after a drug in the accelerated approval program fails its confirmatory trial. The FDA’s website simply states that the agency has “procedures in place that could lead to removing the drug from market.”

FDA press officer Chanapa Tantibanchachai wrote in an email reply to the Foundation for Financial Journalism’s questions, “The FDA is committed to ensuring the integrity of the accelerated approval program. The agency is currently in the process of evaluating oncology accelerated approvals.”

(On April 27, the FDA’s Oncologic Drugs Advisory Committee will hold a public hearing to examine accelerated approval drugs “with confirmatory trials that have not verified clinical benefits,” the agency has announced.)

Over the past two decades, the FDA appears to have shifted away from evaluating a drug solely on its trial data in favor of also including other data sets, according to Dr. Thomas Frieden, a former director of the Centers for Disease Control and Prevention. Thus, U.S. regulators might not remove medications like lurbinectedin from the marketplace in the near future.

At the center of this shifting regulatory landscape is the FDA’s acting leader, Dr. Janet Woodcock, who has served two long stints at the helm of the agency’s Center for Drug Evaluation and Research. Dr. Woodcock has been a vocal advocate of accommodating the pharmaceutical industry to speed the availability of drugs. She is well-known for regulatory leniency toward drugs whose clinical trials cast doubts on their efficacy.

What is less clear is how people with small cell lung cancer would benefit from access to expensive drugs that rarely work well, if at all.

Sacrificing clinical rigor, a casualty of war on cancer

The nature of cancer, and particularly small cell lung cancer, results in very complex and brutal tradeoffs as researchers and pharmaceutical companies hasten to bring new drugs to market.

While the randomized controlled trial has been long accepted as the best way to determine whether a drug is effective and safe for the largest possible population, this method poses problems for small cell lung cancer studies.

A clinical trial’s Phase III — which can take as long as four years to assess a drug’s safety and efficacy against the current standard of care — would appear unwieldy if a disease is causing more than 90 percent of the afflicted individuals to die before five years have elapsed.

One technique developed by clinical researchers is using surrogate endpoints, or substitute evaluation criteria. Researchers believe these data points might correlate with two traditional clinical endpoints: extending life or improving its quality.

For example, the data that initially caught Dr. West’s eye in Phase II of lurbinectedin’s clinical trial was a surrogate endpoint called the overall response rate. (The FDA has at times called it an objective response rate.) This can involve measuring a tumor’s size over a period of weeks as a someone takes a drug. (In lurbinectedin’s case, 35 percent of the study participants, or 37 individuals, had their tumors shrink 30 percent or more, with the effect lasting on average slightly less than five months.)

Another popular surrogate measurement for cancer trials is progression-free survival. This is calculated from the time after tumors stop growing (or disappear) until they grow again.

While progression-free survival and tumor shrinkage are certainly welcome developments, for people with small cell lung cancer they are often temporary events, given how common it is for tumors to grow back.

What’s more, a 2018 report in Clinical Cancer Research found that overall response rate and progression-free survival are poor predictors of a person’s overall survival.

A more detailed analysis of the tenuous links between  response rate and increased patient life appeared in a Journal of the American Medical Association article in May 2019 by three doctors at Oregon Health & Science University: Emerson Chen, Vikram Raghunathan and Vinay Prasad. They examined 85 indications for 59 oncology drugs that were granted FDA approval based on response rate and found that only six of them extended life span. (Some of these drugs were in the accelerated approval program; others were not.)

The FDA does not seem to have taken this research into account, however. In June 2018, FDA researchers published a triumphant review of the accelerated approval program’s first 25 years. From 1992 to 2018, the agency approved 93 indications for 64 products through the program, with only five indications subsequently withdrawn.

But to Harvard Medical School’s Dr. Aaron Kesselheim, the FDA is evaluating its accelerated approval program backward. In a May 2019 JAMA article that made a big splash, Dr. Kesselheim and two colleagues, Drs. Bishal Gyawali and Spencer Phillips Hey, examined the 93 drug indications allowed through the FDA’s accelerated approval program. “We looked ‘underneath the hood’ at the FDA’s basis for approving those [93 indications of] drugs,” said Dr. Kesselheim during a Foundation for Financial Journalism interview. “Our question was simple: ‘Is there evidence that using [the FDA’s accelerated approval] pathway provides drugs that benefit patients?’”

Their answer: not really. Only 19 of the 93 indications investigated by Dr. Kesselheim and his colleagues, or slightly more than 20 percent, demonstrated any improvement in overall survival during Phase III of their clinical trials.

The real problem with the program, said Dr. Kesselheim, lies with the FDA’s use of “surrogate measures that are not clinically validated” for evaluating drugs. “There are valid uses for surrogate endpoints” in clinical trials, he noted: A drug’s effect can be measured faster by using a surrogate endpoint in lieu of a traditional clinical endpoint (which could require two years of study or more.)

“But with no clinical validation, surrogate measures can waste a lot of time,” Dr. Kesselheim added.

Setting standards, while benefitting financially

Another factor in lurbinectedin’s success thus far is tied to the role of the nonprofit National Comprehensive Cancer Network. While most Americans might be unaware of this organization, its work has possibly touched them in some way. As an alliance of 31 cancer treatment hospitals, the network has stated its mission is to develop “evidence-based guidelines” for the screening and treatment of 59 different types of cancer.

Although adoption of the network’s guidelines is voluntary, health care providers broadly accept its opinions for setting the standard of care for these cancer types. The network’s appeal lies in the fact that its 60 panels of experts include not only experienced oncologists but also pharmacists, research scientists and nurses. The panels investigate the minutiae of treatment details and even make their own assessments of various medicines and dosage levels.

Nonetheless, what health care professionals may not clearly see is how responsive to corporate interests the network’s small cell lung cancer panel has been.

On April 29, Francois Di Trapani, Jazz’s vice president for global scientific affairs, wrote the National Comprehensive Cancer Network’s small cell lung cancer panel to request that its clinical guidelines include lurbinectedin as a treatment option. He then followed up on June 15 to alert the panel to lurbinectedin’s selection for the accelerated access program.

By July 7, the nonprofit network’s small cell lung cancer panel had added lurbinectedin to its clinical practice guidelines.

Yet six doctors among the 30 physicians on this small cell lung cancer panel have disclosed that they have received payment from Jazz: five for serving as a Jazz scientific advisory board member, consultant or expert witness, and one other for participating as a Jazz promotional advisory board or speakers’ bureau member or consultant.

Because the Centers for Medicare and Medicaid Services will not update its Open Payments database of corporate payments to physicians to reflect 2020’s totals until sometime this June, the amounts are not yet publicly available.

One of the network’s six small cell lung cancer panelists who received a Jazz payment gave an enthusiastic November interview to a trade publication, touting lurbinectedin’s prospects: Dr. Apar Ganti, an oncologist and hematologist at the University of Nebraska Medical Center, declared to the American Journal of Managed Care that his panel had swiftly acted to recommend lurbinectedin’s use since few drugs are available to treat small cell lung cancer. His interview did not disclose his acceptance of money from Jazz, the very company marketing the drug in the States.

The Foundation for Financial Journalism reached out for comment to Dr. Ganti and the five other physician panelists paid by Jazz, Drs. Anne Chiang, Afshin Dowlati, Jonathan Goldman, Wade Iams and Jacob Sands but did not hear back.

Asked for comment, the network’s CEO, Dr. Robert Carlson, said the panel chose to recommend lurbinectedin’s use in its clinical guidelines based on a Lancet Oncology study published in May. Carlson added that the panel members make guideline updates “as supported by scientific evidence.” Nonetheless, the Lancet study was funded by PharmaMar and one of its authors, Dr. Sands, is among the six physician panelists who received money from Jazz.

Multiple attempts to obtain comment from Jazz’s management were unsuccessful.

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Freedom Holding: After ‘Borat,’ the Silliest Kazakh Import of the Century

If one word could describe the U.S. stock market of 2020, it would be “improbable.” The S&P 500, for example, has risen about 14.14 percent this year despite a pandemic that is deadly to both people and corporate profits. Yet even after witnessing this year’s string of unprecedented developments, investors might be shocked to learn what lies behind the recent muscular share price growth of Freedom Holding Corp. This Las Vegas–incorporated bank and securities brokerage has its principal office in Almaty, Kazakhstan, and a major presence in other cities of the former Soviet Union. 

In Freedom Holding’s most recent quarterly filing of Nov. 19, management attributed the company’s earnings success to customers undertaking a higher volume of trades as a result of “the unique market characteristics surrounding the COVID 19 pandemic.” In other words, quarantined or marooned investors are day trading to pass the time as disease spreads across the world. And thus Freedom Holding’s astronomical revenue growth has seemingly made it the fastest-growing financial services company on Earth.

So why aren’t the big brokerage operations of the U.S. and Western Europe replicating this model? A clue as to why they are not can be found in Freedom Holding’s Securities and Exchange Commission filings. The Foundation for Financial Journalism has found that Freedom Holding serves up gaudy growth figures with few disclosures or incongruous explanations at best — and accompanies them with an operations structure akin to that of a penny stock company.

Despite the fact that Freedom Holding is incorporated in the States and its shares are traded on Nasdaq, nothing about its actual U.S. presence should give American investors any confidence. LinkedIn lists only one U.S.-based Freedom Holdings employee. And the company has situated its U.S. headquarters inside a Regus coworking space. The company’s auditor, Salt Lake City–based WSRP LLC, has just 16 partners and only four publicly traded clients, according to a Public Company Accounting Oversight Board filing. Similarly Freedom Holding’s outside legal adviser, the law firm Poulton & Yordan, has merely two licensed attorneys and no website. All the while, most of the company’s operations — taking place in its trading and retail brokerage division, Freedom Finance — are carried out thousands of miles away in numerous jurisdictions, mostly in Russia, Ukraine and Kazakhstan, but also Europe, and quite actively in Cyprus. 

Although Freedom Holding’s SEC filings do not reveal how it is making its great fortune, its subsidiaries’ audited financial statements do. These filings reveal that the company’s Cyprus unit is staggeringly profitable, having earned more than $33 million last year following a $30,000 loss in 2017. 

Additionally, Freedom Holding has a highly unusual relationship with a company based in Belize that’s owned by Timur Turlov, Freedom Holding’s founder and CEO. While little is disclosed about it in Freedom Holding’s SEC filings, this Belize entity, FFIN Brokerage Services, appears to have access to the funds of Freedom Holding’s clients for as long as 93 days, a major deviation from typical brokerage industry practices across the globe. 

Reporting earnings that might be too good to be true

Analysts reading Freedom Holding’s most recent quarterly filing will be hard pressed to explain its earnings growth. In the first six months of its financial year that ends on March 30, the company had its net income rise to $47.83 million, nearly triple what it reported for the same period a year ago — and more than double the $22.1 million it earned in all of fiscal 2019.

How unique is Freedom Holding’s almost 38 percent net profit margin? Goldman Sachs — long Wall Street’s most profitable company — managed only a 25.3 percent net profit margin in 2006, during the manic run-up to the global financial crisis.

Freedom Holding’s filings suggest that its managers have apparently solved an enduring mystery of the business world: figuring out how to turbocharge revenue growth without triggering a concurrent spike in expenses or risk.

Growing a business typically requires managers to invest in new hires, technology or plant improvements in the hopes that each $1 spent will net $1.50 before taxes in three to four years. But Freedom Holding’s income statements imply that its management can spend 75 cents to realize a return of $3 in just a few months, all without having to sell stock or take on a mountain of debt.

The universe of companies that claim to do this is limited to Freedom Holding. Even profitability and capital efficiency superstars like Google and Berkshire Hathaway cannot approach that performance.

Another factor that sets Freedom Holding apart is its apparent efficiency and productivity. A business in an aggressive expansion mode typically registers a depressed revenue-per-employee figure as it assumes front-loaded costs (adding head count, paying for technology updates) that do not immediately result in new revenue.

Not so for Freedom Holding, though. In fiscal 2019, it generated $81,649 in revenue for each of its 1,343 full- and part-time employees; in 2018 that figure was $65,105 for every one of its 1,141 employees. Adding only 202 employees in fiscal 2019 led the company to triple its net income.

Promising grand returns on IPO shares 

Marketing materials in English on the European version of Freedom Finance’s website present a simple proposition: Tap Freedom Finance to invest in U.S.-listed initial public offerings for a golden ticket to profits. (The website’s Russian text translates into this English prose with Google Translate.)

To whet investors’ appetites, a brochure posted on Freedom Finance’s website declares that since 2012, a set of 107 seemingly randomly picked U.S.-listed companies have reaped returns of 129 percent on average following their IPO.

And a YouTube promotional video for Freedom Holding’s Freedom Finance Europe claims that it secures 50 percent returns on IPOs (after a “three-month lockup” period ends).

Putting aside whether grandiose claims are true or not, Freedom Finance holds no U.S. securities industry registrations or licenses and cannot underwrite U.S.-listed IPOs or participate in the activities of syndicate selling groups. It must rely on other brokerage firms to execute trades on U.S. exchanges for its clients. (In Kazakhstan, Freedom Finance does, however, underwrite IPOs, according to a June 2017 Reuters article.)

Yet Freedom Holding’s clients are buying shares of companies’ initial public offerings – in large quantities. 

Routing transactions to a Turlov outfit in Belize

The way these trades are apparently being accomplished is through a complicated maneuver: Freedom Holding’s clients send money to FFIN Brokerage Services Inc., a Belize City–based broker-dealer whose website promises “direct access to the U.S. market.” Yet FFIN Brokerage Services is not a subsidiary of Freedom Holding. Instead Freedom Holding CEO Turlov owns it, as clearly laid out in Freedom Holding’s July 2018 proxy statement.

Turlov’s ownership of FFIN Brokerage Services seems to be a detail that Freedom Holding is not keen to frequently share. True, the fine print of a 2017 prospectus also alluded to this fact, as did a 2019 Cyprus regulatory disclosure. And, yes, a June 2019 S&P ratings note once described FFIN Brokerage Services as Freedom Holding’s “largest counterparty.” But other Freedom Holding documents, especially its SEC quarterly and annual filings that more investors would regularly encounter, do not mention FFIN Brokerage Services or Turlov’s ownership of it. 

And FFIN Brokerage Services is likely involved with Freedom Holding’s hefty number of related-party transactions. Numerous Freedom Holding’s brochures and contracts instruct clients to send their funds to FFIN Brokerage Services. A Freedom Holding marketing document in May 2017 apparently referred to FFIN Brokerage Services as having “conducted a series of [IPO] deals this year,” per a translation offered by Google Translate. 

Yet, apart from FFIN Brokerage Services’ holding a license to trade foreign currencies in Belize, the company lacks regulatory approvals to execute trades in any other countries. Despite this, a disclosure by Freedom Holding’s Cyprus subsidiary about its top brokers cited FFIN Brokerage Services as handling as much as 9.12 percent of its equity orders in 2019. And Freedom Holding’s 2017 prospectus referred to FFIN Brokerage Services as “a placement agent” for its share offering. 

Perhaps the strangest aspect to FFIN Brokerage Services’ involvement is that Freedom Holding’s clients must abide by an unusual 93-day lockup provision, per a FFIN Brokerage Services document. (At other U.S. brokerage companies, a client order for buying or selling public securities, even as part of an IPO, can be canceled at any point until the order is transacted — without any lockups or restrictions.) 

Nothing in Freedom Holding’s documents — in English or Russian — explains how clients might benefit from the 93-day lockup of their capital. This arrangement, however, could give FFIN Brokerage Services access to plenty of cash for three months, with the sole obligation of delivering the newly issued shares at the end of the period.

Blurring the lines

In its 2019 annual report, Freedom Holding disclosed 12 different types of related-party transactions with Turlov-owned entities. And during the six months that ended Sept. 30, the value of commissions that Freedom Holding earned from its business with Turlov entities amounted to 57 percent of its $126.12 million in sales — or almost $72 million. 

Because Turlov’s related-party dealings with Freedom Holding are so extensive, one can ask if this company has a strong future doing any business unconnected to Turlov.

And cash is going out the door to Turlov-linked affiliates as well: Through Sept. 30, more than one-third of Freedom Holding’s commission payments, or $10.38 million, went to entities owned by Turlov.

While related-party transactions are legal, savvy investors often closely scrutinize them to ensure that executives are not misusing shareholder assets for private gain. To that end, the SEC requires public companies to disclose such relationships in their annual proxy statements. And when public companies have not been forthcoming in describing their role in handling a CEO’s or a board member’s private investments, the SEC has been aggressive in filing claims against such companies and their executives.

Michelle Leder, the founder of Footnoted, described Freedom Holding’s related-party dealings as “more than a bit dizzying.” Her subscription service analyzes public company filings for evidence of potential transactions or misleading data.

“I almost felt like I needed a flowchart to figure [the related-party transactions] all out — lots of money going back and forth between different entities with Turlov being the common link,” Leder said.

One possible explanation offered by Leder for the high volume of self-dealing is that the board of directors of Freedom Holding can’t operate as a counterweight to Turlov since it is a controlled company, according to New York Stock Exchange guidelines. More than 50 percent of its shares are held by one person or entity and thus it’s exempt from SEC requirements for having independent directors.

Raking in capital in Cyprus 

Deeply buried in a regulatory filing of Freedom Holding’s Cyprus subsidiary is a curious detail: The subsidiary, Freedom Finance Cyprus Limited, does not need much capital to generate a lot of revenue. 

Put on the green eyeshade briefly: European Union regulations require that financial institutions set aside 10.5 percent of their tier 1 capital (or the sum of their retained earnings and established reserves) as insurance against unexpected losses. Freedom Holding’s European operations, which consist primarily of its Cyprus subsidiary, reported $42.6 million in tier 1 capital at the end of last year. Thus, as of the end of December, the amount of capital that the company’s European operations (known as Freedom Finance Europe) needed to hold in reserve was a little more than $4.47 million. As a result, the Cyrus subsidiary ended up with $38.13 million in ready capital in its coffers.

To be sure, holding additional cash in reserve for various contingencies is prudent for a company. And given stock markets’ volatility, extra liquidity could mean the difference between life and death for a financial services company like Freedom Holding.

The Cyprus subsidiary’s regulatory filings also reveal a rather remarkable profitability. For fiscal 2019, the subsidiary earned $33.80 million, more than fiscal 2018’s $11.9 million and a considerable improvement over its $30,000 loss in fiscal 2017. As the chart below shows, Freedom Finance Cyprus Limited’s total 2019 income was far greater than the combined incomes of Freedom Holding’s other subsidiaries.


Annual income for 6 Freedom Holding subsidiaries
Sources: audited income statements

Straining for cash in other parts of the organization

Yet while a pile of cash sits at its Cyprus subsidiary, Freedom Holding is showing signs of being desperate for cash in virtually all other corners of its organization. Freedom Finance Europe is offering money market interest rates that are four to six times higher than what U.S. institutions are promising. Banks usually attract depositors for their money market funds by paying a few extra basis points in interest — but not multiples of what a rival does. U.S. regulators often scrutinize banks whose money market interest rates are outliers within the marketplace on the view that management may want to quickly inject cash to conceal previous losses. In fact, the parent company’s main division, Freedom Finance, is paying its brokers a 15 percent commission if their clients deposit 1,000 euros in cash, according to an “agent agreement” posted on its website. 

Furthermore, the way Freedom Holding funds its operations is not congruent with the typical practices of a company that can readily access $38 million in cash. The company’s banking and brokerage subsidiaries in Russia and Kazakhstan, operating under the Freedom Finance umbrella, are funding themselves through sales of short-term bonds with high interest rates — ones even as steep as 12 percent. Unless they have no other option, most corporate management teams would try to use available resources to reduce a drag on earnings from interest expense. 

Exactly what is Freedom Holding doing in Cyprus to make that kind of money? The Cyprus subsidiary’s primary operation is offering Freedom24, an online trading platform it touts as “an online stocks store.” Until earlier this year, Freedom 24 used fraudulent credit card processor Wirecard for payments. Cyprus is also where Freedom Holding has based its nascent Freedom Finance Europe division that’s aimed at capturing business from day traders and individual investors in the Western European market.

Even though the customers targeted are individuals who are new to trading or investing, Freedom24 and Freedom Finance Europe are bare bones offerings in comparison with the mobile applications offered by, say, InteractiveBrokers or TD Ameritrade. 

Partnering with a troubled company to execute trades

Furthermore, Freedom Finance Cyprus Limited is enlisting a brokerage that recently landed in regulatory hot water to carry out its trades: New York–based brokerage firm Lek Securities. The SEC alleged in 2017 that Lek Securities had improperly traded options for Ukrainian clients.

(In October 2019, Lek Securities’ co-founder Samuel Lek agreed to pay a $420,000 penalty and admitted to the SEC that he had broken federal securities laws. Lek Securities paid $1.52 million in penalties and disgorgement and also acknowledged a series of violations. FINRA, in conjunction with other U.S. exchanges, gave Lek a lifetime ban from the securities industry and fined Lek Securities an additional $900,000 for its supervisory failures.)

And Freedom Finance’s tight relationship with Lek Securities goes back years. SEC correspondence shows that in 2015 Lek Securities sought to act as a prime broker for a planned Freedom Finance brokerage in the U.S. named FFIN Securities Inc., for which it would process and match up its trades, as well as serve as a custodian for its securities. (Freedom Finance dropped the project the following year.)

In addition, with Freedom Finance unable to execute its own trades on U.S. exchanges, London-based Lek Securities U.K. Limited last year handled 90 percent of Freedom Finance Cyprus Limited’s equity orders, after doing 99.5 percent of them in 2018. 

Betting it all

Curious as to how such a sprawling operation, with units from Belize to Cyprus and from Almaty to Vegas, emerged? In 2008, while a 20-year-old university student, the Russian-born Turlov launched Freedom Finance in Moscow, and it catered primarily to Russian day traders. Turlov bought a small money management firm in 2013. 

In November 2015, Turlov merged Freedom Finance’s assets with those of Salt Lake City–based BMB Munai Inc., a dormant oil and gas exploration company that had (unsuccessfully) sought to export oil from properties in Kazakhstan. BMB Munia had for a while listed its shares for public trading in the United States. Turlov renamed the newly merged company Freedom Holding Corporation and incorporated it in Las Vegas. In October 2019, Nasdaq listed it on the Nasdaq Capital Market tier of early-stage companies. And just this past August, the company’s Kazakh brokerage unit, Freedom Finance JSC, purchased Bank Kassa Nova JSC in Kazakhstan. This joined the Moscow-based retail bank (FFIN Bank) that Freedom Holding had bought in 2017. 

In a September profile of Turlov, Bloomberg News noted that the financial services assets he had begun cobbling together in 2008 now amount to one of Russia’s 10 largest brokerage firms. A Bloomberg article from October 2017 is more illuminating: Turlov is revealed to have a riverboat gambler’s risk management practices.

Kazakhstan-based Freedom Finance JSC borrowed money using short-term repurchase agreements, pledging its (large) positions in the stocks of a handful of local companies as collateral. The Kazakh brokerage then used that money to expand its market-making activities (such as posting the prices it offers to buy and sell stocks) on the Kazakhstan Stock Exchange. 

This was an incredibly risky strategy. Emerging market equities are frequently thinly traded and volatile. Had the price of Freedom Finance’s pledged stock declined, the firm’s repurchase-agreement counterparties could have either immediately demanded additional cash as collateral or seized (and sold) the pledged shares, threatening the company’s solvency.

Yet as a chart of the Kazakhstan Stock Exchange index shows, Turlov’s gambit worked: Freedom Finance, the exchange’s busiest trader, profited handsomely when the stocks it made markets for gradually increased in value. Freedom Holding’s fiscal 2017 10-K annual report shows a securities trading gain of $23 million, to $33.74 million, from $10.8 million in the prior fiscal year.

– – – – – – – –

In the weeks prior to publication of this article, the Foundation for Financial Journalism sought comments from Freedom Holding. After Adam Cook, the company’s corporate secretary, declined to make Turlov available for a telephone interview, email questions were sent on Nov. 12 and again on Nov. 13. On Nov. 25, Ron Poulton declined to address them, citing the availability of information in its SEC filings and the company’s website. 

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Penumbra Inc.’s Catheter Fail: Broken Tips and Lost Lives

Few things vex a publicly traded company’s managers more than the prospect of admitting a mistake.

To acknowledge an error risks a stock selloff, bad publicity and possible litigation, as well as reduced executive pay and maybe even a few resignations. The alternative — covering up the blunder — could turn what is a professional embarrassment into a potential regulatory headache or even a criminal investigation.

The leaders of Penumbra, an extraordinarily successful Alameda, Californiabased manufacturer of neurovascular devices, have recently found themselves on the horns of this very dilemma.

Some surgeons have alleged that while they attempted to remove blood clots from patients’ brains, Penumbra’s newest catheter would occasionally break or fray, resulting in precious minutes spent addressing the fracture.

Penumbra’s answer baffled them: The company did not acknowledge the problem in any meaningful way; yet it did not fully deny it either.

On July 27, the company released a “Notification to Healthcare Providers,” reiterating its previous instructions for using the catheter, along with a warning against deploying it with non-Penumbra products.

But voluntary reports submitted to a Food and Drug Administration database, including entries from surgeons who have used the new catheter, paint a picture of a device whose safety problems Penumbra may be forced to address in more substantial terms than the July 27 release.

The launch of a modern medical legend

The device in question is the Jet 7 Reperfusion Catheter with Xtra Flex Technology, commonly known as the Jet 7 Xtra Flex.

Introduced with much fanfare at a key industry conference in July 2019, the Jet 7 Xtra Flex is an aspiration catheter designed for use in a procedure called a suction thrombectomy.

As shown in a brief Penumbra video clip, an aspiration catheter is a thin tube that can be inserted inside a person through an opening at the groin or wrist. Guiding the catheter to an arterial brain clot, a surgeon then uses suction to remove it. In this way, the artery’s blood flow can be restored.

In 2007 Penumbra received the first FDA approval to market an aspiration catheter designed to treat individuals who had experienced strokes. Following this, several clinical studies demonstrated the benefits of using an aspiration catheter for interventions after acute ischemic strokes, leading Penumbra to introduce several generations of its pioneering device.

The one-two punch of Penumbra’s being the first to market aspiration catheters with FDA approval and the rapid adoption of suction thrombectomy for the treatment of strokes has made the company’s devices ubiquitous in operating rooms.

From 2007 to 2018, some 80 percent of all the suction thrombectomies performed in the United States relied on Penumbra aspiration catheters, according to brokerage analysts.

Although much larger competitors like Stryker, Medtronic and Terumo introduced their own FDA-approved aspiration catheters in 2018, Penumbra still dominates the market: Penumbra aspiration catheters will play a leading role in nearly 65 percent of this year’s 45,000 to 50,000 suction thrombectomies in the U.S., according to projections by analysts during a Feb 25, 2020, Penumbra conference call.

From a business standpoint, Penumbra’s Jet 7 Xtra Flex catheter is a superstar, possibly accounting for at least 30 percent of the company’s sales last year. A research report that aggregated 2019 U.S. hospital purchasing orders put Jet 7 Xtra Flex sales to such facilities at $168 million, or 30.7 percent of the company’s total revenue. (An outside spokeswoman for Penumbra declined to provide specifics, citing the company’s policy of not disclosing precise sales figures.)

Penumbra’s success at improving its bottom line has propelled its share price ever higher, to its current $199.43, giving the 16-year-old company a gaudy $7.485 billion market capitalization.

MAUDE’s unflattering accounts

After Penumbra’s decade plus of success, the company now faces a very real quandary. The FDA’s Manufacturer and User Facility Device Experience (MAUDE) database lists 11 deaths that occurred after operations in January through the end of July that involved the Jet 7 Xtra Flex. The MAUDE database has one such report of a death after an operation last year; Penumbra rolled out the new catheter commercially in mid-2019.

MAUDE is an informal, voluntary reporting system for public tracking of adverse events like injuries and deaths involving any piece of medical equipment approved for use in the U.S. A wide array of individuals, including medical professionals, family members of people operated on, as well as company representatives, can submit entries to MAUDE, so the reports vary in their amount of detail. And unlike a clinical study or an autopsy, MAUDE entries are not necessarily recorded in a scientific or medical fashion.

(In this manner, MAUDE resembles another database, the FDA Adverse Event Reporting System, which is a repository of adverse pharmaceutical event reports. The Foundation for Financial Journalism used FAERS data to reveal a pattern of significant numbers of fatal drug reactions from products sold by Corcept Therapeutics, Acadia Pharmaceuticals and Insys Therapeutics.)

Despite their limitations, MAUDE records are certainly valuable for anyone hoping to detect a possible trend.

All 12 MAUDE entries detailing deaths after 2019 and 2020 operations that involved the Jet 7 Xtra Flex catheter mentioned the device’s distal tip suddenly expanding or fracturing. And eight reports noted at least one arterial rupture – with many of the ruptures cited as occurring in the internal carotid artery, which supplies blood to the brain and eyes. (One reported death, after an April 24 operation, involved a person with COVID-19, a condition that may have complicated that individual’s outcome.)


Reported Deaths After Use of Jet 7 Xtra Flex
Source: 2020 MAUDE data

When asked about the 11 deaths from January through the end of July listed in the MAUDE database, Penumbra’s marketing chief Gita Barry acknowledged that the company is aware of the reported deaths, stating, “Penumbra filed medical device reports for all adverse events with the FDA which are reflected in the MAUDE database.”

Barry added, “Following our investigation into the reports, we worked diligently to communicate directly with physicians.”

A formal investigation is not required before someone submits a MAUDE entry. And only two of the 11 reports concerning 2020 procedures entries about surgeries on June 8 and April 28 overtly alleged that the fatalities were linked to Jet 7 Xtra Flex problems. Three other entries categorized the relationship between the Penumbra catheter and a death as “unknown.”

Nine MAUDE entries describing 2020 operations, however, claimed the Jet 7 Xtra Flex either fractured or expanded shortly after a surgeon began a cerebral angiography. In the latter type of procedure, a catheter is injected with an iodine contrast dye to make the artery and the clot visible on X-rays. Angiography has been a standard component of clot-removal surgery for years.

To be fair, the Jet 7 Xtra Flex’s label — rendered in small print — clearly warns against injecting contrast dye into the catheter and also recommends it not be used with non-Penumbra products. Plus, anyone undergoing neurovascular surgery after having a stroke or an aneurysm is indeed at a heightened risk for having numerous complications, including death.

But Penumbra’s insistence that its catheters are safer to use when paired with other Penumbra products flies in the face of current medical practice, according to three neurovascular surgeons interviewed by the Foundation for Financial Journalism. (These doctors spoke on the condition of anonymity due to their employers’ prohibitions on talking with the press, and one surgeon had even received speaking fees from Penumbra.) All three doctors said use of Penumbra’s aspiration catheters with non-Penumbra devices is a “nearly universal practice” of surgeons performing thrombectomies.

“I like the Jet 7 [Xtra Flex catheter] well enough,” said one of the three physicians. “But I don’t like nearly anything else [Penumbra] has out. So I use a microcatheter, stents and coils from other companies.”

All 11 MAUDE reports detailing 2020 procedures referred to this mix-and-match practice. The entry about a March 15 operation, for example, noted the doctor had used a Jet 7 Xtra Flex alongside “a non-Penumbra microcatheter and non-Penumbra revascularization device.”

Since surgeons who treat strokes tend to live by the creed “time is brain” (meaning speed is of the essence when trying to prevent long-term neurological impairment), they are unlikely to want to swap out a Jet 7 Xtra Flex (after performing a suction thrombectomy) for another catheter to do the angiography.

Penumbra’s Barry, however, insisted that injecting contrast dye into an aspiration catheter is exactly what doctors should avoid doing. “Reperfusion catheters are designed for the removal of stroke-causing clots by aspirating or suctioning the clot out of the arteries in the brain, and not for contrast injection,” Barry said. Using the aspiration catheter for the dye task runs the risk of reintroducing a clot into the brain’s arteries, which could prompt an additional stroke, she added.

Two of the three surgeons interviewed by the Foundation for Financial Journalism said they do change catheters when performing an angiography during a suction thrombectomy. “But there is an expectation that the [aspiration] catheter can withstand an injection,” one doctor noted, adding that at times using the same catheter for both tasks is clinically valuable.

New wrinkles in the competitive landscape

Maybe the most problematic aspect for Penumbra concerning MAUDE lies with what is not described there: deaths related to competitors’ aspiration catheters. MAUDE carries no entries (filed through July 31) for Medtronic’s React 68 and 71, Stryker’s AXS Vecta 71 and Terumo’s Sofia Plus aspiration catheters.

And a key Penumbra competitor has seized on Jet 7 Xtra Flex’s troubles as a marketing opportunity. Medtronic has been running a digital advertisement on its neurovascular unit’s LinkedIn page, touting its aspiration catheter’s ability to “manually deliver contrast injections.” The logic behind Medtronic’s running the ad is simple: While few surgeons probably spend much time on LinkedIn, Penumbra sales staffers — unaccustomed to marketing a device whose safety profile is being questioned — might be weighing their career options, and some of them may be tempted to defect.

On Aug. 27, Piper Sandler research analyst Matt O’Brien hosted a virtual “fireside chat” for his firm’s money management clients with Stacey Pugh, general manager of Medtronic’s neurovascular unit. Boldly assessing her company’s performance this past summer, she said, “Candidly, we’ve been very pleased with our average daily sales [of aspiration catheters] since that notice went out,” referring to Penumbra’s July 27 missive.

Medtronic’s sales in Japan are being helped by what Pugh described as a “voluntary recall” of Penumbra’s Jet 7 Xtra Flex, she said. “There’s a void in the marketing of [Penumbra’s] product in Japan” that has created a built-in sales growth opportunity for Medtronic, she asserted. (Pugh’s candor may have been bolstered by the Piper Sandler event’s closure to the press.)

Asked about Pugh’s description of a “voluntary recall” in Japan, Penumbra’s Barry replied, “No, this is not true. The product has not been recalled in Japan.” Penumbra’s Japanese distributor “paused sales” while her company updated the Jet 7 Xtra Flex’s “instructions for use,” she said. After Japanese regulators approve the catheter’s new instructions, the device will be restocked, Barry claimed.

The Japanese market accounted for 7.8 percent of Penumbra’s sales in 2019, or $42.5 million, according to its annual report.

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Fundamental Global Investors: Everyone Loses

Illustration: Edel Rodriguez

Running a hedge fund requires a starkly different skill set from what’s required to manage a publicly traded company.

Yet hedge fund managers Kyle Cerminara and Lewis Johnson, the co-founders and co-managers of Charlotte, North Carolina–based Fundamental Global Investors, have been doing both.

In 2015, Cerminara and Johnson began to closely direct the operations of three publicly traded companies in Fundamental Global Investors’ now $127.3 million-in-assets portfolio: Ballantyne Strong Inc. of Charlotte, North Carolina, BK Technologies Corp. of West Melbourne, Florida, and 1347 Property Insurance Holdings Inc. of St. Petersburg, Florida.

But after five years of Fundamental Global Investors’ oversight, all three of these public companies have weakened financially and their share prices have collapsed. Many minority investors in these three public companies, as well as the hedge fund’s limited partners, have absorbed steep losses.

A just-completed in-depth Foundation for Financial Journalism investigation has uncovered how, despite Cerminara and Johnson’s apparent mismanagement of these public companies, the two money managers are doing quite well for themselves.

Cerminara and Johnson have received a combined $6 million in fees and compensation from the companies they control since 2015, according to Securities and Exchange Commission filings.

This is unusual: Despite the hedge fund industry’s legacy of excesses, most fund managers typically keep their interests at least broadly aligned to their limited partners. Nearly every hedge fund has a so called high-water-mark provision, prohibiting a manager from taking performance fees (and thereby sharing in the profits) until limited partners’ losses are fully recovered.

Cerminara and Johnson have circumvented these norms. Just as important, their decisions appear to have rarely favored all investors: Cerminara and Johnson have steered clear of buying back stock or making substantial investments to improve these public companies’ operations.

Their strategy might be best referred to as parasitic investing: Cerminara and Johnson are faring well, but Fundamental Global Investors’ limited partners are suffering along with the employees and minority shareholders of these public companies.


Fundamental Global Investors has owned 50 percent of Capital Wealth since 2013. Staffed with 31 advisers, Capital Wealth Advisors has $1.56 billion in client assets under management, according to its most recent regulatory disclosure.

A crucial aspect to Fundamental Global Investors’ stake in Capital Wealth is its history of achieving significant profits. Since most registered investment advisers charge clients a fee of 1 percent of assets under management, Capital Wealth’s current $1.5 billion in assets is likely generating about $15 million in annual revenue.

In contrast to the thinly capitalized underpinnings of many hedge funds that operate independently of a corporate parent (and are thus unable to absorb sustained losses), Cerminara and Johnson have their Capital Wealth Advisors income stream. This gives them the financial freedom to pursue an atypical strategy for their hedge fund. Fundamental Global Investors has embraced the high-risk strategy of holding small capitalization stocks in its portfolio for years at a time.


Cerminara and Johnson met while working at T. Rowe Price over the last decade and founded Fundamental Global Investors in 2012. The third FGI partner is Joseph Moglia, who at the time of the fund’s founding was then chairman of TD Ameritrade’s board of directors. (From 2000 to 2008 he was also TD Ameritrade’s CEO.)

While Moglia is one of Fundamental Global Investors’ three general partners he does not manage any of its portfolios. In 2013 Capital Wealth appointed Moglia as its chairman, a position he retains today along with chairing TD Ameritrade’s board. (Moglia also spent seven years as the head coach of the football team at Coastal Carolina University in Myrtle Beach, South Carolina, until January 2019.)

During Moglia’s tenure Capital Wealth has benefited substantially from its ties to TD Ameritrade: Through TD Ameritrade’s AdvisorDirect referral program, Capital Wealth has picked up about $400 million in new assets since 2014. And Capital Wealth’s assets under management have grown from $200 million in 2013 to almost $1.5 billion in 2020.

Like most registered investment advisers, Capital Wealth has a client base primarily composed of high-net-worth individuals who have diverse sources of wealth and varying levels of capital markets exposure. The firm’s co-chief investment officers regularly provide their staff advisers and clients a model portfolio, replete with recommendations for weighting assets, such as stock, bonds and cash, according to their tolerance for risk.

And Capital Wealth’s co-chief investment officers just happen to be Kyle Cerminara and Lewis Johnson, Fundamental Global Investors’ leaders. They have regularly suggested that Capital Wealth’s clients assign 5 percent to 10 percent of their portfolios to so-called alternative investments (such as hedge funds or private equity). Nonetheless, Fundamental Global Investors has not had much luck in attracting many of Capital Wealth’s wealthy clients to invest in its hedge fund as limited partners.

Until 2018 a key recommendation of Cerminara and Johnson was promoted in Capital Wealth’s model portfolio: Clients should acquire their own shares of Ballantyne Strong, BK Technologies and 1347 Property Insurance Holdings.

Capital Wealth stopped this practice in 2018 for two reasons: The three companies’ poor share price performance led several Capital Wealth advisers to opt out of marketing Cerminara and Johnson’s model portfolio to clients. And the combined value of the stakes in these three companies owned by Capital Wealth and Fundamental Global was so large relative to the daily trading volume of the three stocks that concerns were raised about Capital Wealth clients’ ability to sell their stocks in an orderly fashion.


About one-fifth of Fundamental Global’s capital has come from its three general partners: Cerminara, Johnson and Moglia. That’s $26.9 million of its $127.3 million in capital, according to Fundamental Global’s March 30 Form ADV filing.

No limited partners appear to be institutional investors: The Foundation for Financial Journalism searched hedge fund databases ― both those publicly available and private ones ― and could not find any records of a pension fund or another institution that had invested in Fundamental Global.

Institutions such as pension and sovereign wealth funds, private foundations and university endowments have traditionally been key sources of capital for hedge funds. These institutions (or their advisers) often conduct rigorous due diligence before investing in hedge funds. And even after making an investment, such institutions require extensive communication from a fund’s general partners about the results.

Lacking such oversight, Cerminara and Johnson have proceeded to run their hedge fund in a rather unique fashion.


Consider the actions Fundamental Global has taken with Ballantyne Strong, a maker of both digital movie equipment and taxicab signage.

Fundamental Global has spent almost $26.9 million to buy 5,994,857 shares of Ballantyne Strong, according to Ballantyne Strong’s Schedule 13D filings from Sept. 3, 2014, to March 16, 2020. With Ballantyne Strong’s stock priced at just $1.50 a share as of May 4, Fundamental Global Investors’ shares are now worth about $8.85 million, meaning the fund has lost slightly more than $18 million from these purchases.

Of course, virtually every professional money manager has made investments that have not panned out, and most limited partners recognize that.

Nonetheless, since November 2015 when Cerminara became Ballantyne Strong’s CEO, Ballantyne Strong’s revenue has declined and its losses have mounted. (In 2015 Ballantyne Strong took a $11.2 million charge against its earnings to reduce expenses and reorganize its operations; this helped it report a profit in 2016, the only time it did during Cerminara’s tenure.) On April 15 Ballantyne Strong announced that Cerminara is no longer its CEO; he is now the non-executive chairman of the board.

Sharp market observers would be unsurprised that no pension or sovereign wealth fund has opted to become a limited partner of Fundamental Global as it has continually added capital to a losing bet (Ballantyne Strong) for more than half a decade.


The first instance of Fundamental Global’s unusual use of its related public companies’ capital cropped up nearly five years ago. On Nov. 16, 2015, Fundamental Global disclosed that it had used Ballantyne Strong’s cash to purchase a block of shares of 1347 Property Insurance Holdings, a residential property insurer with operations primarily in Florida, Louisiana and Texas.

This transaction seems to have become a template of sorts that Fundamental Global has repeatedly used over the next couple of years to carry out elaborate cross-ownership stock schemes with Ballantyne Strong, BK Technologies and 1347 Property Insurance Holdings. Under Fundamental Global’s management, the balance sheets of these three public companies have rapidly expanded and contracted with one another’s shares.

From November 2015 to February 2017, Cerminara and Johnson spent $7.71 million of Ballantyne Strong’s cash to purchase a little more than 1 million shares of 1347 Property Insurance Holdings.

The primary benefit to Fundamental Global Investors from using Ballantyne Strong’s balance sheet appears to have been capital efficiency: Less of Fundamental Global Investors’ own capital had to be expended for it to attain voting control over 1347 Property Insurance Holdings. As of April 22, Fundamental Global Investors controls 50.4 percent of 1347 Property Insurance Holdings.


Another clear demonstration of how Cerminara and Johnson have used Ballantyne Strong’s cash to further Fundamental Global Investors’ goals surfaced on Dec. 21, 2015, when Ballantyne Strong disclosed its nearly $4.3 million purchase of 1.14 million shares of BK Technologies (then known as RELM Wireless). On Sept. 9, 2018, Fundamental Global Investors bought these very shares for $4.53 million, generating a $200,000 profit for Ballantyne Strong. (In addition, during this period, BK Technologies paid $600,000 in dividends to Ballantyne Strong.)

On the surface, Fundamental Global Investors’ use of Ballantyne Strong’s cash to buy and hold a BK Technologies stake for almost three years might appear to have paid off for Ballantyne Strong’s shareholders, by generating a modest 6.7 percent annual return on investment.

But a closer look at Ballantyne Strong’s filings reveals a very different picture.

While Fundamental Global Investors was directing Ballantyne Strong to spend more than $12 million to build its stock positions in both BK Technologies and 1347 Property Insurance Holdings, one of Ballantyne Strong’s key subsidiaries was strapped for cash: In April 2017 it borrowed money against its headquarters building. A year later, Ballantyne Strong orchestrated a sale-leaseback transaction for this property. (A sale-leaseback deal, allowing a company to sell an asset and lease it back for a period of time, can indicate that the business is under acute financial stress.)

The sale-leaseback filing, attached as an exhibit to Ballantyne Strong’s 2018 annual report, lays out the deal’s fine points: the $7 million price tag for the Alpharetta, Georgia, facility and the $612,000 annual charge for leasing it back. After closing the deal, Ballantyne Strong immediately paid down a $2.94 million debt to BlueHarbor Bank from a term loan and a lien against the headquarters.

Until late 2019 Cerminara served on this bank’s board; Ballantyne Strong disclosed in 2018 that Fundamental Global Investors held “less than five percent” of BlueHarbor Bank equity.

Jim Marshall, BlueHarbor Bank’s CEO, recently explained Cerminara’s departure from the board of Blue Harbor Bank to the Foundation for Financial Journalism in this way: “He wanted to leave quietly and we saw no problem with that,” said Marshall, adding, “He is a busy man, with a lot of irons in the fire.” (Cerminara retains a BlueHarbor Bank tie since Capital Wealth still operates an investment advisory joint venture with BlueHarbor Bank that it initiated in 2014 under the name BlueHarbor Wealth Advisors.)

Marshall declined to discuss the specifics of BlueHarbor’s loan to Ballantyne Strong other than declaring, “Everything [about the loan] was above board and beyond reproach.”

All told, Ballantyne Strong has become a weaker, less healthy company in terms of revenue, net income and cash generation since Cerminara took the helm as CEO in November 2015.

Shareholders have borne the brunt of the company’s decline: On Sept. 3, 2014, the date that Fundamental Global Investors disclosed its initial equity stake in Ballantyne Strong, the company’s market capitalization was $63.24 million. On May 4, 2020, it was only $22.26 million.

Yet despite this destruction of the company’s value, from 2015 to 2019 Ballantyne Strong paid slightly more than $2.6 million to Cerminara and Johnson in compensation and director’s fees, with almost $2.33 million of that going to Cerminara.


A misalignment similar to the one between the interests of Ballantyne Strong’s majority shareholders and those of its minority investors has also occurred at BK Technologies.

Established more than 70 years ago, BK Technologies has a mission, according to its website, “to remain deeply rooted in the critical communications industry for all military, first responders, and public safety heroes.” And 45.1 percent of its shares are owned by Fundamental Global Investors.

On March 17, 2017, when Cerminara became BK Technologies’ chairman of the board, its share price was $5.10, and the company had just announced it had $2.68 million in net income for 2016. Three years later, BK Technologies reported a cumulative $6.45 million in losses. Now its share price is just $2.30.

It is likely cold comfort to BK Technologies’ minority investors that they have fared somewhat better from this arrangement than Fundamental Global Investors’ limited partners. Fundamental Global Investors purchased a cumulative total of 4.97 million BK Technologies shares for $20.09 million, according to filings from Sept. 3, 2014, to March 17, 2020. The limited partners’ stake in BK Technologies is now worth only $13.47 million, representing a loss of $6.61 million for all the limited partners.

Yet, from 2015 to 2018, BK Technologies paid a total of $763,265 to Cerminara and Johnson, or $405,215 and $358,050, respectively, for their serving as chairman and co-chairman of its board of directors. (Cerminara and Johnson did not respond to an April 8 question from the Foundation for Financial Journalism about whether Fundamental Global Investors’ limited partners had been directly told about these payments.)

On April 24 BK Technologies announced that Cerminara and Johnson had resigned their roles as co-chairmen of its board of directors, in a move that became effective immediately. They retain positions as directors of the board.


Much like what Ballantyne Strong and BK Technologies shareholders have experienced, Fundamental Global Investors’ involvement with 1347 Property Insurance Holdings has done no favors for its investors.

On June 15, 2015, the date Fundamental Global Investors reported that it had begun building a stake in 1347 Property Insurance Holdings, the company’s market capitalization was $50.64 million. By May, it had plummeted to $27.68 million.

In addition, the limited partners of Fundamental Global Investors are hardly benefiting from its investment in 1347 Property Insurance Holdings. The 3.05 million shares of 1347 Property Insurance Holdings that Fundamental Global Investors purchased for almost $22 million are now worth just $13.94 million, leaving Fundamental Global Investors’ limited partners and Capital Wealth’s clients with an $8 million loss from this investment.

Cerminara and Johnson became chairman and co-chairman, respectively, of 1347 Property Insurance Holdings’ board of directors in May 2018. In 2019 Cerminara and Johnson each earned $165,000 in director fees, and since 2017 have earned a combined total of $750,772 from these duties.

But a recent corporate restructuring at 1347 Property Insurance Holdings makes its situation very different from the dynamics at play at Ballantyne Strong and BK Technologies. Cerminara and Johnson, as the general partners of the hedge fund that owns 50.4 percent of 1347 Property Insurance Holdings’ stock, are carefully remaking the public company from the bottom up and taking care to ensure they have numerous opportunities for profit at every turn.

On Feb. 25, 2019, the management of 1347 Property Insurance Holdings agreed to sell its property insurance operations to FedNat Holding Company for $51 million. By Dec. 31, 2019, the sale was completed and all these operations were transferred to FedNat. Thus, 1347 Property Insurance Holdings began this year without any specified business operations.

But what apparently makes 1347 Property Insurance Holdings so attractive to Cerminara and Johnson is that the company has no debt and nearly $6 a share’s worth of liquid assets: cash, FedNat stock and other investments. And with 1347 Property Insurance Holdings’ current share price of $4.56, the company is trading at a discount to its book value, a rare occurrence for a publicly traded company.

Typically when a company’s stock is trading at a discount to its book value, investors will take advantage of the pricing inefficiency by buying the stock, sending the share price back into line with its book value. Alternatively, investors could decide to liquidate the company and distribute the assets on a pro rata basis and obtain roughly the same level of risk-free return.

What Cerminara and Johnson have in mind is apparently something different.
On March 30, 2020, the management of 1347 Property Insurance Holdings issued a press release announcing a June name change for the company to Fundamental Global Financial Corporation, along with plans to launch a reinsurance company, invest in real estate and provide asset management services.

But by April 6, the managers of 1347 Property Insurance Holdings disclosed a “shared services agreement” with a newly created entity, Fundamental Global Management LLC. This agreement requires 1347 Property Insurance Holdings to pay Fundamental Global Management’s owners $1.82 million a year for management and advisory work. While the agreement stated that it was between 1347 Property Insurance Holdings and “affiliates” of Fundamental Global Investors, the “owners” of Fundamental Global Management were not named. One logical guess is that the “owners” are none other than Cerminara, Johnson and Moglia.

A tiny clause in this agreement also assigned 1347 Property Insurance Holdings responsibility for reimbursing Fundamental Global Management for its operating expenses.

The April 6 agreement also announced the formation of a joint venture between 1347 Property Insurance Holdings and Fundamental Global Investors called Fundamental Global Asset Management. This new entity is charged with identifying investment management funds; it will offer to provide them seed capital in exchange for taking equity stakes. Fundamental Global Investors is also granted the right to offer the opportunity to invest in these funds to a “third party” if the amount of capital required is greater than $5 million.

There is a catch: According to a 2018 hedge fund industry study by the Seward & Kissel law firm, even seeding deals for smaller funds can require commitments of $20 million or more. While the April 6 agreement does not explicitly state it, Cerminara and Johnson will likely use Fundamental Global Asset Management to identify and finance smaller investment management firms and tap Capital Wealth’s wealthy clients to fund larger deals.


Cerminara and Johnson’s side deals for Fundamental Global Investors achieved by their dipping into these three public companies’ assets are not the full extent of their quirky dealings with publicly traded enterprises.

The filings of little-known Itasca Capital of Vancouver may demonstrate the purest expression of Fundamental Global Investors’ use of a public company for private gain. Itasca Capital’s board of directors includes Cerminara and Johnson, and the company has no operations.

Itasca Capital’s structure is similar to that of a Russian nesting doll: Its only asset is 1347 Investors LLC, a holding company that is jointly managed by Cerminara and Larry Swets Jr. (This second executive, Swets, founded Kingsway Financial Services, a predecessor of 1347 Property Insurance Holdings.) And until very recently, 1347 Investors LLC itself had just a single asset: a $10 million investment in redeemable preferred stock issued by Limbach Holdings, an unprofitable commercial contractor. That investment was redeemed on Nov. 19, 2019, and 1347 Investors LLC netted a respectable 10.79 percent annualized return on the investment for Swets, Cerminara and others.

Under Cerminara and Johnson’s direction, Ballantyne Strong in 2016 spent $3.7 million to purchase shares of Itasca Capital; today Ballantyne Strong owns 32.3 percent of Itasca Capital.

Over roughly three years Ballantyne Strong has received $2.9 million in dividends from Itasca Capital, but that sum must be weighed against $1.2 million in write-downs.

Cerminara and Johnson receive modest annual payments for being members of Itasca Capital’s board of directors. In 2018, the last year for which information is available, Cerminara received $10,000 for being Itasca Capital’s board chairman, and in 2017 he made $10,833. Johnson, who joined the board in 2018, was paid $5,833.

Ballantyne Strong’s investors would be well served to ask why their company still owns Itasca Capital. And Fundamental Global Investors’ limited partners should be curious to know why Fundamental Global Investors did not participate in the profitable 1347 Investors LLC transaction with Limbach Holdings.


In addition to all their other engagements, Cerminara and Johnson serve as co-general partners of yet another similarly named entity, FGI 1347 Holdings LP. This fund’s sole investor is BK Technologies. Yet FGI 1347 Holdings LP’s only asset, apart from $197,000 in cash, is 477,282 shares of 1347 Property Insurance Holdings. These shares had had been previously purchased by BK Technologies in March and May 2018 for $3.74 million. (BK Technologies disclosed on April 28 that Fundamental Global Investors does not charge any fees for its management of FGI 1347 Holdings LP.)

Tying up almost $4 million in cash, this investment in FGI 1347 Holdings LP must be documented on BK Technologies’ income statement. Thus the swings in FGI 1347 Holdings LP’s value significantly affect BK Technologies’ profits. In 2019, as the share price of 1347 Property Insurance Holdings dropped, the value of BK Technologies’ stake in FGI 1347 Holdings LP declined by $1.1 million, and in 2018 it dipped by more than $1.8 million.


For all Cerminara and Johnson’s other activities and maneuvers, their main claim to fame as financiers – running their nearly 8-year-old hedge fund – has been a dramatic failure from the perspective of its limited partners. Fundamental Global Investors’ filings show the hedge fund, the three main public companies it controls and Capital Wealth’s clients spent $72.67 million on the shares of Ballantyne Strong, BK Technologies and 1347 Property Insurance Holdings. The part of Fundamental Global Investors’ portfolio invested in these three public companies and Itasca is now worth just $37.55 million.

While the Foundation for Fina’ncial Journalism could not obtain Fundamental Global Investors’ exact performance results, Securities and Exchange Commission filings paint an ugly picture of the fortunes of the fund’s limited partners. A comparison of Fundamental Global Investors’ SEC Form D filings since 2012, which list each time it has raised capital, with its most recent Form ADV filing, containing each of its funds’ current value, indicates that the hedge fund’s amount of capital has sharply fallen.

Because most limited partners are content to leave a profitable investment alone, a hedge fund’s capital would typically decline only if realized losses occur or redemptions are made.

From Sept. 6, 2012, to May 21, 2019, Fundamental Global raised a total of $236.75 million for 14 different funds. The fund’s March 30, 2020, Form ADV lists $127.39 million in capital from all these funds.

The Fundamental Global fund that has experienced the most profound decline in assets under management is the Fundamental Global Partners Master Fund LP.

With three different feeder funds that investors have contributed to since September 2012, the Fundamental Global Partners Master Fund LP has taken in $105.18 million. These feeder funds had only a total of $17.92 million in capital left by March 30, 2020. Given the fact that Fundamental Global Partners Master Fund LP has been operating for almost eight years, much of the decline in assets has likely resulted from wealthy investors redeeming their investments.

One fund alone among Fundamental Global Investors’ 14 offerings was a bright spot in 2019: The CWA FGI Special Opportunities Fund LP posted about a 12 percent return. Orchard Global Asset Management manages its portfolio through its Taiga fund, and Cerminara and Johnson have no investment responsibilities for this account. The fund’s $20.3 million in assets were raised in November 2018 primarily from 37 Capital Wealth clients.


The Foundation for Financial Journalism made extensive efforts to obtain comment from the three general partners of Fundamental Global Investors. After an exchange of text messages with Kyle Cerminara, an April 8 email to Cerminara, Johnson and Moglia requested a response to 13 questions. A follow-up email went out on April 20, and Cerminara gave a brief reply. On April 24 another set of 13 questions was sent. On May 3, a last request for comment was made. There was no response.

Corrections:  An earlier version of this story erroneously stated that Kyle Cerminara and Lewis Johnson had received a combined $6 million in fees and compensation from Fundamental Global Investors since 2015. But the source of that $6 million was the three public companies they control.

In addition, this article originally stated Cerminara and Johnson had resigned BK Technologies’ board of directors. In fact, they resigned as the board’s co-chairmen but remain directors.

The original version also erred in stating Fundamental Global Investors spent $72.67 million on shares of Ballantyne Strong, BK Technologies and 1347 Property Insurance Holdings. Fundamental Global Investors, the three main public companies it controls and Capital Wealth’s clients purchased this amount. These corrections were made in May 2020.

The piece was also corrected and updated on Dec. 2, 2021, to change the article’s title to reflect the fact that losses to the limited partners of Fundamental Global Investors resulted from its unsuccessful asset allocation strategy, as opposed to abusive conduct by the general partners. 

Three paragraphs in the original article incorrectly noted that Capital Wealth Advisors owned a 50 percent stake in Fundamental Global Investors and that a real estate fund FGI Metrolina, then managed by Cerminara and Johnson, had purchased the mortgage of a Ballantyne Strong facility in Alpharetta, Georgia. These paragraphs were deleted. 

Update: This article was updated with share prices of May 6, 2020.

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Q3 I LP: The Cryptic Doctors of Persuasion

Until late last year Dr. Quan Tran, a St. Petersburg, Florida, surgeon had an unusual side hustle. He served as one of three general partners of Q3 I LP, a cryptocurrency hedge fund that he helped launch in August 2017.

Q3 I LP has had few rivals in recent capital markets history: It has claimed monthly returns of 13 percent to 15 percent — and annual returns of 180 percent or more for its first two years of operation. The fund’s managers promoted its investment strategy as a model of prudent risk management: avoidance of margin loans and 70 percent of assets kept in cash at all times.

Dr. Tran, 44, heartily embraced his self-appointed role as Q3 I LP’s chief marketer, persuading other physicians to invest at least $50,000 apiece to become limited partners of the fund. He did this by tapping into several loose, informal doctor networks that coalesced around a Facebook group named Physician Dads’ Group. By October, according to an email Dr. Tran wrote to a prospective limited partner, Q3 I LP had supposedly raised $236 million.

But on Feb. 11, Dr. Tran’s efforts to help build Q3 I LP’s assets under management devolved into a horror show when federal prosecutors from the Southern District of New York unsealed an indictment, charging wire fraud and money laundering against his ex-partner Michael Ackerman, the fund’s former head of trading.

Concurrently, the U.S. Securities and Exchange Commission and the Commodity and Futures Trading Commission on Feb. 11 filed their own complaints against Ackerman. The CFTC complaint also named Q3 Holdings LLC and Q3 I LP as defendants but did not cite Dr. Tran or the funds third general partner, James A. Seijas. (In the SEC complaint, Dr. Tran and Seijas are identified as “Founding Partner 1” and “Founding Partner 2,” respectively. Ackerman, Dr. Tran and Seijas each owned one-third of Q3 Holdings LLC, the holding company for Q3 I LP.)

The Southern Investigative Reporting Foundation (now called the Foundation for Financial Journalism) first got wind of Q3 I LP’s problems in December when a medical professional whom Dr. Tran had pitched reached out to express reservations about the purported astronomical returns. While Dr. Tran’s claim of having doubled the size of investments annually would be suspect enough on its own, especially at a time when the cryptocurrency market was especially volatile, the tip included unusual elements: The limited partners’ actual losses were possibly quite large. Based on the emails and documents the prospective investor provided, the fund bears all the signs of an affinity fraud — not the type plotted in a high-pressure boiler room but something brought to life through a few Facebook groups, email lists and group texts.

Since December one theme has emerged from all the interviews conducted for this investigation: The shared educational and professional experiences among a diverse group of physicians engendered a level of trust among them so deep that it took only a few Facebook posts and screen captures to lead them, Pied Piper like, into financial disaster.

Below is an account, based on six weeks of interviews and federal court filings, of how one person with an incredible story used two other people who were willing to shout it from the digital rooftops to allegedly steal about $34 million from some very well-educated people.


It’s not clear how Dr. Tran, Michael Ackerman and James Seijas first met. Perhaps Ackerman and Seijas became acquainted on the floor of the New York Stock Exchange, where both had worked for more than 15 years in the 1990s and early 2000s as a broker and specialist, respectively.

With an initial $15,000 investment, the three formed the Q3 Trading Club in June 2017 to speculate in cryptocurrencies, according to the Feb. 11 SEC complaint. Rather than trying to pick individual winners and losers from varied cryptocurrency offerings in the market, they used a trading algorithm that Ackerman has said he developed in 2010 to trade stocks but found effective for the trading of currencies.

(Cryptocurrencies are privately constructed units of digital payment that have gained prominence over the past decade. While having no established intrinsic value like a nation’s currency, several well-known cryptocurrencies like Bitcoin and Ether have become popular assets that are used for investing as well as peer-to-peer payments. Yet in addition to the regulatory and technological hurdles that cryptocurrencies face before their widespread adoption, they have attracted no shortage of hucksters and scams.)

Within a month of the Q3 Trading Club’s June 2017 launch, the three founders were seeking out investors. Dr. Tran’s position in the Facebook Physician Dads’ Group proved to be valuable for attracting interest, according to interviews of former Q3 I LP limited partners and the SEC and CFTC complaints.

Previously in June 2017, Dr. Tran had registered an entity called Q3 Crypto LLC at his home address, with Tran, Ackerman and James Seijas’ wife, Donna, listed as board members. (By January 2019, after Q3 Crypto LLC had stopped making the required state filings, Florida’s secretary of state classified it as “inactive.”)

But in August 2017 just as the Q3 Trading Club’s coffers had about $1 million, Ackerman’s trading strategy failed. This resulted in what the CFTC later called “substantial trading losses.” Ackerman announced to his two partners that he would completely redesign his algorithm. 

One former Q3 Trading Club investor informed the Southern Investigative Reporting Foundation that Dr. Tran had told him that after Ackerman adjusted the trading strategy in the fall of 2017, the monthly returns would be 13 percent to 15 percent.

And that is exactly what happened.

Even though the cryptocurrency markets collapsed in 2018, Ackerman’s new trading system delivered monthly returns of 14 percent to 16 percent — what market observers would consider a breathtaking performance. (One index that tracks the monthly performance of 26 cryptocurrency trading hedge funds showed an almost 72 percent  decline in 2018 as compared with the prior year.) 

At this point Ackerman, Tran and Seijas probably reckoned that if this new strategy could deliver more than 180 percent on the initial million dollars, then a hedge fund (with possibly a much larger capital base) might bring almost limitless rewards.

Thus in November 2018 the three Q3 Trading Club founders launched a new fund, Q3 I LP, with the goal of raising $15 million from limited partners. Their fee arrangement was unusual; the fund documents said the general and limited partners would split the profits 50-50, after paying what was described as “minor expenses.” (Most hedge funds charge a management fee of 1 percent to 2 percent of the assets and a performance fee of 20 percent to 25 percent.)

For investors, the fee structure did not appear to be a sticking point, however. From November 2018 to December 2019, Q3 I LP raised more than $33 million from 150 limited partners.

Dr. Tran and Seijas each further invested $250,000 or more in Q3 I LP, according to an affidavit of Homeland Security Investigations’ Special Agent John Rodriguez that prosecutors unsealed on Feb. 11. (The Tran family’s financial exposure to Q3 I LP is  significantly greater than $250,000: Dr. Tran’s brother-in-law, Seth Duhy told the Southern Investigative Reporting Foundation he had invested $1 million in the fund.)

But Q3 I LPs general partners omitted or soft-pedaled some important details in the limited partner agreement and the subscription booklet.

Among the glossed-over matters: Q3 Holdings LLC general partners (Ackerman, Seijas and Dr. Tran) would charge limited partners capital “licensing fees” for Q3 I LP’s right to use Ackerman’s retooled algorithm. That added up to $4 million in payments to the trio from November 2018 to December 2019.

And according to the SEC’s complaint, in December 2018 the Q3 Holdings LLC general partners did not notify their limited partners that they had decided to keep for themselves any profits above the 15 percent benchmark.

Yet that was a minor detail compared to what else the federal prosecutors allege Ackerman omitted, especially about Q3 I LP’s true rate of return.


According to federal prosecutors, as well as the SEC and CFTC, Ackerman’s reworked algorithm was nothing more than a cover story he developed in August 2017 to begin a two-year campaign of fabricating Q3 I LP’s jaw-dropping 180 percent annual return.

For regulators and investors alike, figuring out where all the money went won’t be a light task — as has been the case after the collapse of other investment funds due to fraud. 

Of Q3 I LP’s $33 million in limited partner capital, only about $10 million was invested in various cryptocurrency exchanges, according to the SEC.

So what happened to the other $23 million? Based on the federal indictment and the SEC and CFTC complaints, about half, or $11.5 million, of this amount can be traced in a straightforward fashion. Whether that can be recovered and returned to the limited partners is a different story.

To start with, Ackerman paid himself about $7.5 million in fake performance fees from the $23 million in capital. Per the federal indictment, prosecutors are seeking to compel him to forfeit five properties he bought in 2018 and 2019 with this money, including a 154-acre plot in Montana and a $3.6 million house in Delray Beach, Florida. (Property records for the Delray Beach home list James Seijas and Donna Seijas as the owners, however.

Ackerman also spent $600,000 on personal security services, $100,000 on Tiffany’s jewelry as well as an additional sum on three cars, according to the SEC.

(This does not include the $4 million in licensing fees the three Q3 Holdings LLC general partners raked in from limited partner capital to pay for the right to use Ackerman’s algorithm.)

In an attempt to explain what happened to the additional $11.5 million share, the CFTC complaint points to $3 million of it being used in a Ponzi-like fashion to meet a limited partner redemption request. Where the other capital lies is still unclear.

Figuring out how the fraud happened is not as difficult.

Ackerman told Dr. Tran and Seijas that Q3 I LP’s trading accounts had safeguards in place to prevent him from withdrawing money without a second partner’s approval. Yet, according to the SEC and CFTC complaints, Ackerman withdrew money at will.

Having total control over Q3 I LP’s finances, Ackerman could use basic software to create account balances that showed whatever he wanted them to. His favorite tactic, according to the SEC, was to modify screenshots of the fund’s account statements to inflate the portfolio’s value: On Sept. 1, 2019, Ackerman sent Dr. Tran a text message that showed Q3 I LP’s account balance as slightly less than $182 million, although in truth only $1.5 million was available. Three months later, when the account balance was $428,000, he allegedly sent Dr. Tran and Seijas a screenshot that indicated an account balance of just  under $310 million.

Given the fact that Dr. Tran and Seijas did not handle Q3 I LP’s brokerage accounts, no regulator has suggested they had anything to do with creating fake performance numbers.

Their value to Ackerman was in helping to raise new capital, especially by immediately passing on what he said — or the documents he manufactured — to current and prospective limited partners.

Just as important, they appear to have taken Ackerman’s word on everything.

That’s understandable in Dr. Tran’s case since he had no professional financial services experience. So when Ackerman fed Dr. Tran nonsensical talking points to help him explain Q3 I LP’s returns, he repeated them without raising any questions. Dr. Tran wrote to prospective limited partners that the fund’s secret is a “proprietary stratagem” that focuses on a financial ratio called “correlated capital forfeiture.”

That phrase appears to be absent from finance textbooks: Stephen Cecchetti, a professor of international finance at Brandeis University, told the Southern Investigative Reporting Foundation he had never heard of the term, and a Google search for the phrase also struck out.

Seijas’ lack of oversight seems less explicable. His resume describes 26 years of finance work, including almost 11 years of serving as a financial adviser to high-net worth clients. It’s reasonable to suppose he might have understood that, compared with even much smaller investment funds, Q3 I LP had almost no controls at all.

Many hedge funds arrange for an independent fund administrator to provide monthly or quarterly profit and loss statements to limited partners. And most funds hire an accounting firm to perform an audit at the end of the fiscal year. In contrast, as the SEC has alleged, Dr. Tran and Seijas were forwarding to Q3 I LP’s limited partners screenshots from Ackerman’s cellphone as performance updates. Dr. Tran would then calculate limited partners’ pro rata share of profits and send out the account statements.

Furthermore, Q3 I LP does not appear to have had a prime brokerage relationship. Typically large banks serve as prime brokers to clear and settle trades for hedge funds, as well as hold their cash balances and serve as custodians of their securities portfolios. If Q3 I LP had a prime broker, Ackerman would not have had the ability to inflate the fund’s account balances.

Dr. Tran appears to have been especially adept at raising capital. In January, two Q3 I LP limited partners told the Southern Investigative Reporting Foundation that Dr. Tran’s posts on his personal Facebook account convinced them the fund really was doing well.

And Dr. Tran went on an extensive shopping spree from mid-2018 through the autumn of 2019 and posted all the details on his refreshingly immodest personal Facebook account. (This seems to contrast sharply with Ackerman’s behavior; federal prosecutors allege Ackerman concealed his property purchases by putting other people’s names on the titles.)

For a vacation in June 2019, Dr. Tran took his family for pricey luxe stay to the Maldives, according to his Facebook posting. In August 2019 Dr. Tran posted pictures of his new 50-foot Okean motor yacht (whose base sticker price was roughly $1.14 million) and in November 2019 of his 2018 Bentley Continental GT (that retailed for at least $264,300). Dr. Tran appears to have paid cash for both, according to a search of uniform commercial code filings. (By late January, Dr. Tran had shut his Facebook account.)

The Southern Investigative Reporting Foundation in December sent Dr. Tran a lengthy question about these purchases. He did not respond. In late January,  

Dr. Quan Tran, right, his wife, Evan Elizabeth, and his brother-in-law, Seth Duhy, attend a Nov. 9, 2019, performance of “Moulin Rouge” in Manhattan. Source: Facebook
Dr. Quan Tran, right, attends a Nov. 9, 2019, performance of “Moulin Rouge” in Manhattan with his wife, Evan Elizabeth, and his brother-in-law, Seth Duhy. Source: Facebook

On Dec. 13, 2019, Ackerman sent an email to some Q3 I LP limited partners apologizing for the “endless delays the past month” in providing them performance figures, according to Special Agent Rodriguez’s affidavit. Ackerman said that because of a health problem that had led him to pursue treatment in New York City, he was suspending the fund’s trading for the rest of December and all of January.

Less than 30 minutes after Ackerman sent that email, Dr. Tran sent his own email to Q3 I LP limited partners and offered a very different take on Ackerman and the fund’s health, per Special Agent Rodriguez’s affidavit. Following Ackerman’s Dec. 3 departure from a hospital stay, Dr. Tran wrote, he and Seijas visited him at his house in Sheffield Lake, Ohio: After gaining access to his computer, “[We] discovered what appeared to be a very large discrepancy between the assets [Ackerman] had been reporting to us and the balance in the trading account.”

Dr. Tran said that when confronted about this alleged discrepancy, Ackerman claimed he had moved the assets to another, more secure trading account but refused to name where it was or give Dr. Tran and Seijas access to it, according to Special Agent Rodriguez. Soon afterward, they alerted the SEC’s Miami regional office about the issue, Dr. Tran said.

When news of the regulators’ investigation of Q3 I LP spread across the informal physicians networks in mid-December, “it felt kind of like you’d been struck by lightning, it was so sudden,” said one physician and limited partner, “except getting hit by lightning probably doesnt make you feel betrayed and foolish.”

Upon learning of Q3 I LP’s looming troubles, a pair of friends who had become fund limited partners, Lafayette, Colorado-based Dr. Anthony Kokx and Morgantown, West Virginia-based Dr. Jaime Miller, hired a lawyer to investigate the fund. They referred all questions to their lawyer, Mark Hunter.

Reached in mid-January, Hunter would say only “we’re in the early stages of an investigation and I’m trying to obtain the facts.” He added, “Hopefully I will be able to say more soon.”


Over the course of the investigation into Q3 I LP’s collapse, the Southern Investigative Reporting Foundation identified seven of its limited partners: Miller and Kokx, as well as five other individuals. These five limited partners spoke on the condition of anonymity because they were actively cooperating with federal regulators and law enforcement officials.

Q3 I LP’s general partners did not respond to multiple inquiries from the Southern Investigative Reporting Foundation, including emails posed to Ackerman and Dr. Tran. Nor did they respond to voice messages. And James Seijas did not reply to messages left at his Shrewsbury, New Jersey, home.

Paul Flannery, a lawyer at Flannery, Georgalis LLC who represented Ackerman in his Feb. 14 arraignment in Cleveland, declined to comment on Feb. 17 about his case. Flannery said his firm is still determining if it will represent him in the future.

Updates: This file was updated Feb. 18, 2020, to reflect details gleaned from Homeland Security Investigations’ Special Agent John Rodriguez’s affidavit about alleged irregularities associated with Michael Ackerman’s management of Q3 I LP’s portfolio. A comment about lawyer Paul Flannery’s representation of Michael Ackerman has also been added. 

An earlier version of this article incorrectly identified James Seijas’ wife, Donna. The story was updated on March 2, 2020. The Foundation for Financial Journalism regrets the error.

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Fraser Perring: Chronicles of Deceit, Part I

A high-profile research analyst who identifies and bets on troubled companies has acquired an unusual and perhaps unwarranted amount of influence in the brief period of time he’s been in this line of work.

Forty-six-year-old Fraser Perring, a resident of Lincoln, England, founded and runs Viceroy Research with two other analysts. Their investigations of what they claim are misleading corporate disclosures or flawed business models have regularly sent the stock prices of their targets spiraling downward.

Perring is a short seller who appears to relish the attention that comes from being publicly bearish on companies in a marketplace that seems largely designed to push stock prices higher. And with no client funds to manage (Perring trades only for his own account) and thus few regulatory disclosures to make, he is free to discuss his globe-trotting lifestyle with a reporter or use his Twitter account to launch broadsides against anything that irks him. His Viceroy Research Twitter account has more than 17,100 followers and his personal account has 4,471.

His brash, unapologetic approach to the traditionally closemouthed, insular business of short selling drew significant attention, with Perring snagging an endorsement from the well-known former fund manager Marc Cohodes in a 2018 Bloomberg News profile and striking up dialogues with influential hedge fund managers like Bronte Capital’s John Hempton and Valiant Capital’s Eduardo Marques.

Short sellers rarely pass up an opportunity to critique an executive’s duplicity or accuse brokerage analysts and auditors of compromising their ethics for money. Of course, short sellers need not be saints, but someone who makes his money pointing out the market’s con artists shouldn’t be one himself.

But as revealed by a seven-month investigation by the Southern Investigative Reporting Foundation, Perring is a charlatan of the first order, with a brazen multiyear record of personal and professional deceit. It makes one wonder, If Perring is fudging the truth to reporters about houses and cars, what else is he not on the level about? A lot, it turns out.

Take Perring’s globe-trotting lifestyle. In January, Mail on Sunday reported that he owned houses in London, New York City and Oregon, liked to race supercars and has a Mercedes-AMG valued at 200,000 pounds. It’s certainly a remarkable picture of what Perring had achieved since mid-2012 on Wall Street. But property records and asset searches for both the houses and the car came up empty. Jamie Nimmo, the Mail on Sunday reporter who wrote the article, told the Southern Investigative Reporting Foundation that Perring had been the source of those details.

The first part of this investigation lays out Perring’s erratic and troubling conduct, including some dubious methods to generate interest for his research on stock message boards and his impersonating a well-known hedge fund manager. Part two will examine the real forces backing and benefiting the business model of Perring and many other activist short sellers.


Born August 5, 1973, in Canterbury, England, Fraser John Perring spent his early years on his parents’ pig farm in Cornwall before heading off to boarding school. He has told people that he attended Nottingham Trent University and studied a prelaw curriculum; the university declined to confirm this, citing privacy concerns.

What Perring did from age 21 to 38 is not particularly well-known, although it included stints as a pub worker and a chef. When asked to provide a copy of his résumé covering this period, Perring refused. And in an October interview with the Southern Investigative Reporting Foundation, his wife Jeannette also declined to discuss his background “out of respect.” She and Perring, who have been separated for years, are “going through the process” of obtaining a divorce, she said.

His parsimony with dispensing the truth can be traced to the summer of 2012 when Perring turned his day-trading hobby into a career.

See more detail in “A Short Foray Into Social Service” on how Perring’s conduct as a social worker gives a hint about his later Wall Street behavior.

Perring focused his efforts on deep-dive research and trading of the many problem-ridden companies listed on the London Stock Exchange’s Alternative Investment Market, or AIM. Launched in 1995 as a way for embryonic companies to access public capital (reminiscent of Nasdaq in the 1980s), AIM by 2012 was less a showroom for promising startups than a lightly regulated twilight zone for penny stocks.

The exchange’s relaxed listing requirements have often attracted companies whose weaker asset bases and modest finances have prevented them from qualifying for more established exchanges. The managements of numerous AIM-listed companies have developed a reputation for being aggressively promotional as they strive to boost their stocks’ share prices. This has frequently presented attractive opportunities for short sellers to await the expected decline in stock prices after companies fail to live up to their promises.

That Perring (or any short seller) would be attracted to AIM-listed stocks is perhaps not surprising. But the way he went about things was.

Ian Hollins, childhood friend

In 2008 Perring created an account with ADVFN, a London-based message board that is popular with day traders. Starting in 2010 he began to frequently post there using the name FJP73 and gradually built up a following through posts that were alternately informal and deeply researched. Then Perring’s posts started to receive comments from someone with the handle Ian Hollins — supposedly his childhood friend and a trader.

Ian Hollins’ posts initially promoted Perring’s ADVFN posts. Sometimes Hollins’ support was subtle and at other points it was downright sappy, like when a Hollins post said about Perring, “I am surprised you waste your valuable time coming on this thread.”

Eventually the posts of Hollins (described in his own comments as a London trader of 18 years who moved to Jakarta, Indonesia, for tax reasons) began to disclose how a good friend (presumably Perring) had provided him valuable advice to “de-risk”  investments.

In April 2013 Perring launched a no-frills stock commentary website Erratic Market Coverage, with Hollins listed as a contributor. While Perring wrote nearly every post, one of the few posts attributed to Hollins touted Perring’s work: Hollins’ April 17, 2013, post referred to Perring’s valuations of gold mining stocks as “excellent” and called him “a far better trader than I.”

(Perring has since reassessed his own trading skills: In the January Bloomberg News profile cited above, he claimed he was not a very good trader. Perring also stated as much in several 2017 and 2018 conversations with the Southern Investigative Reporting Foundation, noting that his poor trading skills led him to work harder as an analyst.)

In June 2015 Perring archived documents on the open publishing platform Scribd that were related to litigation between Churchill Mining PLC and Indonesia (a favorite message board topic for Perring) as well as 23 pages of Hollins’ message board posts on the subject.

A casual ADVFN visitor might not have heavily scrutinized Hollins’ posts but they had an odd timing to them. Hollins’ first posts appeared in August 2010, with only a dozen more added from January 2011 to June 19, 2012. And comments from the FJP73 moniker (of Perring) stopped on Dec. 19, 2010, until 2013. It certainly looks like the hands behind the FJP73 and Ian Hollins accounts were busy doing something else for almost 19 months. Indeed, Perring was busy working as a social worker from Jan. 1, 2011, to June 27, 2012.

But why would the Hollins personage — someone supposedly rich enough to be in tax exile — spend countless hours writing and responding to message board posts about the fate of penny stocks and the machinations of nearly bankrupt companies?

At first Hollins’ message board posts provided support to Perring (by citing virtually identical investments and research views, all while using a writing style like his). But as Perring’s research career began to gain steam and members of his professional circle went from just day traders to including professional money managers on both sides of the Atlantic, Ian Hollins’ presence also changed. This Hollins persona began to surface as a frequent reference point in Perring’s real-life conversations with his colleagues and investors interested in his research.

In this way Ian Hollins’ public profile grew into one of a brilliant commodities trader who had followed the investment counsel of his close friend Fraser Perring and thus reaped a fortune in London only to now live regally in Indonesia. The implication was clear enough: Unlike Perring, mere ordinary day traders lacked a tight working relationship with an ultrarich friend like Hollins.

This past summer London-based hedge fund manager Matthew Earl shared with the Southern Investigative Reporting Foundation how Perring had described a lucrative deal that Hollins had supposedly struck with an Asian mining company — to pay him a 100 million-pound royalty each year. (In interviews, eight investment bankers who specialize in advising energy and natural resources companies said they had not heard of such a transaction, and several of them expressed skepticism that an established mining company would forge this type of a deal.)

“Fraser told me [that Hollins] was a superrich former RBS commodities trader,” Earl said during a London interview in July.

“Hollins was a sort of omnipresent background figure [in Perring’s relationship with me] and Fraser was always discussing how Ian might put some of his own money to work with us,” Earl added.

Fahmi Quadir, a New York–based short seller who had at one point dated Perring, said in an August interview that Perring repeatedly mentioned Hollins and even said he would make an investment in her then-nascent fund Safkhet Capital. Both Quadir and Earl told the Southern Investigative Reporting Foundation that no investment from Hollins ever materialized. (Point of disclosure: In December 2016 Quadir donated $2,000 to the Southern Investigative Reporting Foundation; in August this donation was returned.)

Quadir found that Perring’s persistence in mentioning Ian Hollins started to veer into the absurd. She described in detail to the Southern Investigative Reporting Foundation the following London episode: Perring suggested that she stay in his apartment on a London trip to meet with Eli Gabso, the manager of Sage Global Capital, and Perring.

But after arriving in London, Quadir discovered “Fraser’s apartment” was simply an Airbnb rental that Perring had arranged for her. “Someone’s name was on the mail on the counter and they had their clothes in a closet,” Quadir recalled.

In the morning Perring asked Quadir to tell Gabso that she was staying in Hollins’ place. Quadir said nothing in reply, but resolved that if she was asked, she would tell Gabso the truth. Perring then told her that Gabso was suspicious about whether Hollins existed. (And Perring insisted that he did not want Gabso to know the number of Perring’s properties.)

“It was obvious Fraser didn’t own it; he didn’t know his way around that neighborhood,” Quadir later recalled. “And he couldn’t even help me with the [apartment’s] Wi-Fi or heating. When Eli [Gabso] asked me where I was staying, before I could say anything, Fraser said, ‘at Ian’s place.’”

After searching British property records, the Southern Investigative Reporting Foundation could not find any indication that Perring owned a property in London. In April Perring sold his house in Lincoln, England, for 187,500 pounds and moved to another residence in the same community.

Sage’s Gabso told the Southern Investigative Reporting Foundation in October that Perring had often mentioned Ian Hollins when discussing investments. When Gabso tried to investigate Hollins’ background but found nothing, Gabso asked Perring to provide proof that Hollins was real, only to have Perring change the subject, Gabso recalled.

In response to pointed questions from the Southern Investigative Reporting about Ian Hollins in late September, Perring said that name is an alias he invented to refer to a real friend. Quadir says Perring told her in January 2019 that Hollins died from complications from an enlarged heart. Yet, the Southern Investigative Reporting Foundation found no mention on the internet of an English commodities investor in his mid-40s who passed away that month.

Indeed, Hollins’ posts were what’s popularly called “sock puppeting,” whereby someone posts comments from a fake persona on an internet forum to boost his (or her) own views.

Perring also invoked Hollins in a January 2019 encrypted Signal message conversation with Safkhet’s Quadir. In the exchange, reviewed by the Southern Investigative Reporting Foundation, Perring told Quadir that analyst Kuldip Ambastha of Los Angeles-based wealth adviser Aspiriant LLC, with almost $11.7 billion under management, had recently emailed him asking for his assessment of her money management skills. The message read as follows: “We have looked from afar for a few months but rate your opinion on the basis you have turned us down many times and suspect Fahmi will or charge us a lot. We would be happy with the latter.”

Perring told Quadir that Ambastha had known Hollins well and Aspiriant had made “14x” off Hollins. But the Ambastha email had so many flaws that it’s difficult to imagine that Ambastha, with a decade of experience in the investment management field, could have written it.

Aspiriant, an advisory firm for high-net-worth clients, charges set fees for its services, so it’s unclear what sort of compensation scheme Perring was referring to. And why would Aspiriant, a prospective limited partner in Quadir’s fund, say the fund’s fee structure did not matter? Plus, the claim that Perring had turned down numerous investments from Aspiriant seems highly improbable. If Aspirant (or any financial adviser) allocated client capital to a small research firm with no money management capabilities, this would be a large legal and regulatory risk. And Ambastha’s discussing Aspiriant’s desire to invest in Safkhet in January would be odd since he had left Aspiriant 10 months earlier.

In a September email exchange with the Southern Investigative Reporting Foundation, Ambastha alleged that Perring had fabricated the email query from him about Quadir; he said he and Aspiriant had never sought to invest with Perring or Safkhet.

Ambastha said he had emailed Perring a brief complimentary note in January wishing him good luck after he read his Bloomberg News profile. He said he had once casually corresponded with Quadir two years earlier after he saw her mentioned in a February 2017 Bloomberg News article about short seller Marc Cohodes. (Point of disclosure: In 2017 Marc Cohodes contributed $344,593.20 to the Southern Investigative Reporting Foundation.)

Quadir confirmed that she had received from Ambastha only a February 2017 email. And Ambastha provided to the Southern Investigative Reporting Foundation copies of the actual emails he sent to Perring and Quadir.

Replying to a question about Ambastha’s alleged email to him, Perring wrote in September, “I am unsure of the Aspiriant’s reference but have been contacted by them in the past via [my company Viceroy’s] general email address.”

Misleading a business contact about the amount of property one owns would be childish; deceiving a friend about prospective sources of capital for her newly launched business is a uniquely cruel sort of lie. Both actions speak volumes about a person’s private life. But after Perring became involved with money managers, lying became central to how he operated professionally.

A strained research partnership

In the fall of 2015 Perring secured a big break: Through a mutual acquaintance, he managed to arrange a phone call with Matthew Earl, whose reputation had been made five years earlier as a brokerage analyst who recommended selling the shares of outsourcing providers Connaught PLC and Xchanging.

The purpose of Perring’s call to Earl was to explore a mutual interest in Wirecard AG, a German payments company. Perring had told the mutual acquaintance he felt Wirecard’s shares were sharply overvalued and Earl had just released a report on the company on his fund’s blog, Lordship Trading, and had already shorted its shares. (The Southern Investigative Reporting Foundation reported in 2018 and 2019 on Wirecard’s dubious Asian transactions but without tapping Earl as a source.)

See why the Southern Investigative Reporting Foundation wrote about Perring in “Editor’s Note on Fraser Perring.

Perring’s first call to Earl, which ran roughly 90 minutes, convinced Earl that Perring did not know much at all about Wirecard, Earl recalled. Perring told Earl he was a private investor with a history of shorting the stocks of troubled companies with large market capitalizations.

Despite Earl’s reservations about Perring’s claims of having an esteemed track record, Earl agreed to keep discussing Wirecard with Perring and compare notes with him on an ongoing basis. (Earl recalled that Perring told him that he had been one of the earliest short sellers of Valeant Pharmaceuticals International stock and had been in touch with the Southern Investigative Reporting Foundation during its reporting on the company. The Southern Investigative Reporting Foundation did not, however, use Perring as a source for its reporting on Valeant.)

An odd dynamic emerged as the two conducted research on Wirecard, Earl said in a September interview: When Earl and Perring talked on the phone, “Fraser was often lost and didn’t understand the [financial concepts] behind what I’d uncovered.” But on their Skype chats, Perring would submit very original and polished research, Earl said. In excitement, Earl would then call Perring to expand on what he’d just posted, only to hear him once again struggle to discuss it.

“What was happening was that Fraser found someone similar to me and [he] would just copy and paste their research into Skype,” Earl said. Apparently, Perring had found an analyst willing to provide him copies of his research notes. About two months after Earl and Perring began their collaboration, Earl confronted him about the strange dynamic. Perring admitted that he had a source providing him research work, Earl recalled. Earl said he eventually made contact with this person but declined to name the individual.

Despite their unequal participation in the research process, Earl structured a 50-50 partnership with Perring in an outfit they called Zatarra Research & Investigations; Earl said in a September interview he had reasoned that Perring was reasonably adept on the internet sleuthing front since he was repeatedly surfacing key documents. Zatarra’s business model involved shorting the shares of companies identified by Earl and Perring as troubled and then publicly releasing their findings. Additionally, the two partners figured that as Zatarra’s track record grew, hedge funds might pay a handsome price for its research services. (Earl said that the name Zatarra came from a moniker bestowed on the protagonist Edmond Dantès in the 2002 movie version of Alexandre Dumas’ “The Count of Monte Christo.”)

When asked about Zatarra’s distribution of labor, Perring in an email reply described Earl’s effort as centered on writing, whereas his activity focused on research. This point, when later shared with Earl, made him laugh. “Fraser did some document retrieval and the Zatarra website; that’s it. Everything else was me,” Earl said.

On Feb. 24, 2016, Zatarra released the first of five reports on Wirecard and attracted positive notice from the likes of the Financial Times and Bronte Capital, hedge fund manager John Hempton’s popular finance blog.

Hedge fund managers were soon reaching out to Zatarra to learn more about its work. One fund manager who reached out in late February 2016 was John Fichthorn, the general partner of Dialectic Capital; his New York-based hedge fund then had about $500 million in assets under management and Fichthorn had shorted Wirecard’s shares several months earlier. In a September interview with the Southern Investigative Reporting Foundation, Fichthorn said he had thought it would be productive for him to connect with someone from another fund to discuss the challenge of researching a very complex company. (Point of disclosure: In February 2014, Fichthorn’s Commeo Fidenter Foundation gave $4,950 to the Southern Investigative Reporting Foundation.)

Fichthorn said that his fund Dialectic had only one contact with Zatarra: a meeting with Perring and a member of Quintel Financial Intelligence, an outside forensic research firm hired by Fichthorn in 2015 to dig up and analyze Wirecard’s European and Asian filings.

Yousef Al-Majali, the co-founder of Quintel (now called Oculus Financial Intelligence), recalled meeting with Perring. In an October interview with the Southern Investigative Reporting Foundation, Al-Majali said he provided Perring the research commissioned by Dialectic but was not very impressed with the depth of Zatarra’s work. “I can tell you that based on what I got from the one meeting, [Quintel’s research] was way ahead of them on documenting what [Wirecard] had done,” Al-Majali said.

And according to Fichthorn, the one meeting with Quintel’s Al-Majali was the extent of Dialectic’s dealings with Zatarra. “We never compared notes with [Zatarra]; that’s for sure,” Fichthorn said. In a September interview, Fichthorn expressed astonishment about Perring’s “strange fantasy” that his one meeting with a Quintel representative amounted to a business relationship with Fichthorn.

Channeling a mysterious Ryan Vaughan

Perring, however, represented matters very differently to Earl, according to Earl’s recollection. In June 2016 Perring told Earl what he thought was very good news: John Fichthorn was willing to pay Zatarra 100,000 pounds annually for its research work. To discuss the deal, Perring proposed a three-way Skype messaging chat between Perring, Earl and Fichthorn. Earl agreed and when the time came, Earl logged on — only to find Perring and a “Ryan Vaughan” waiting for him.

In an October interview, Earl recalled phoning Perring to ask who Ryan Vaughan was, and Perring said it was John Fichthorn. Perring, Earl said, told him how the allegedly secrecy-obsessed Fichthorn would regularly use pseudonyms to conceal his identity when discussing investments with people outside his fund.

Earl also recalled that when he and Perring chatted by Skype or sent email, they often referred to other people by their initials for security purposes. Thus to Earl, Perring’s reply of “J” on the Skype chat meant John Fichthorn, Earl remembered.

Perring and Earl had several perfunctory Skype chats with this “Ryan Vaughan” before “I put down my foot,” Earl recalled. At this point, Earl demanded a phone call with Fichthorn.

And the resulting call was surreal, Earl recalled. “It was a horrid connection and lasted maybe a minute,” Earl said. “The speaker had a sort of John Wayne accent. To me, it was obviously Fraser [Perring] pretending to be American. When I tried to ask a question about what was going on, [the call got] cut off.”

After the call, Earl said, he calmly explained to Perring that Zatarra would have nothing more to do with Fichthorn or the Vaughan character without a call to discuss the parameters of their research relationship — and a contract.

Perring, in an email response to the Southern Investigative Reporting Foundation, denied that this whole set of Vaughan exchanges had occurred but recalled that Earl had accused him of posing as Vaughan. And Perring said he and Earl regularly used pseudonyms when conducting meetings about Wirecard, especially when journalists were involved; he did not respond to a follow-up question about who he thought Ryan Vaughan might have been. (For his part, Earl said the only time he did not reveal his identity during this period was during a Der Spiegel interview, in accordance with agreed-upon conditions.)

In August 2016 Earl became angry after receiving a Skype text message from “Ryan Vaughan,” seeking to discuss Wirecard, Earl recalled. Earl refused to engage with this Skype account unless its identity was revealed. Then “Fraser [Perring] called me and told me that Ian Hollins had made the introduction to Ryan Vaughan, who had explained [to him] it was really John Fichthorn,” Earl said.

“What? That’s hilarious,” said Fichthorn, when the Southern Investigative Reporting Foundation shared Earl’s details of the episode. “It’s insane bullshit, but it’s really very funny.” Fichthorn denied that he had ever used pseudonyms in his business dealings and said Zatarra had never had a consulting relationship with Fichthorn’s Dialectic.

In late August 2016 the “Ryan Vaughan” drama intensified, Earl recalled in an interview last week. Perring claimed to Earl that John Fichthorn had given him permission to use a Twitter account @FollowValue1 that supposedly belonged to Fichthorn to send tweets critical of Wirecard. (Twitter later suspended this account for violations of the company’s terms of service.)

In a series of Aug. 26, 2016, Skype messages with Perring, Earl confronted Perring about tweets that this account had sent the previous evening, disclosing the contents of an upcoming Zatarra research note.

“I really don’t believe any of this,” Earl wrote to Perring. “There’s no way [John Fichthorn is] going to give you his Twitter and if so why would you tweet about contents of [a] forthcoming note?”

By way of explanation, Perring said he had gone to a pub, “got tipsy” and sent “some stupid tweets.”

“Wow,” wrote Fichthorn when reached for comment. “That’s fucking excellent.” Fichthorn unequivocally stated no one, including Perring, had ever had access to his personal Twitter account and that @FollowValue1 was not Fichthorn’s account.

For Earl, the August call and Skype messages became the final straw in a series of what he called “inexplicable events” that led him to end his Zatarra partnership with Perring.

But before that, Earl endured what he referred to as “the Vodafone incident,” when Perring, upon returning in July 2016 from a family holiday on the Turkish coast, related a fantastic tale.

An unusual business proposition

That July Perring recounted to Earl that he had just had a chance encounter at his hotel’s bar with Vodafone’s head of mergers and acquisitions, who made over drinks what Perring described as an astonishing — and unsolicited — proposition: Perring alleged that for a 15,000-pound payment, this British telecom executive would leak to Zatarra details of upcoming acquisitions.

Moreover, according to Perring, this executive claimed to have worked out a foolproof way to arrange for the illegal payment for material nonpublic information: First, Perring would sell his older car to this executive for about 3,000 pounds. After a brief period, Zatarra could buy it back from him for 15,000 pounds. Then the executive would provide Zatarra the relevant information. And Perring would theoretically handle all the details of this operation.

Earl’s response to Perring when he learned of the offer? “No, absolutely not,” Earl recalled. Earl said he told Perring that throughout his career he had been fully compliant with Financial Conduct Authority rules, and insider trading was clearly forbidden.

“Even if I wanted to [engage in insider trading], I don’t know that I’ve heard a more cock-and-bull story in my life,” recalled Earl, who added that he still wondered what had prompted Perring to think he might believe his tale.

Perring, when asked about Earl’s recollection, said, “I don’t comment on anecdotes.”

A Vodafone spokesperson did not respond to an email request for comment. (The Southern Investigative Reporting Foundation found no evidence that a Vodaphone executive engaged in this conduct.)

By August 2016 Earl had quite enough of Perring; Earl had already been planning to open what is now his current business, ShadowFall Capital & Research, without Perring. All that remained was for the two men to settle up accounts: Their agreement called for them to produce their trading records and share 50 percent of the proceeds (less expenses) with each other.

But in October 2016 Perring told Earl that he owed Perring 100,000 pounds for what he termed research expenses. In reply, Earl said the only expenses Perring could have incurred were for the design and launch of Zatarra’s website, and Earl asked for related receipts. Perring said he didn’t have any since he had paid for everything in cash. Earl countered that Zatarra’s website designer might have been paid in cash but Amazon Web Services, Zatarra’s hosting provider, couldn’t have been, and the total expenses should not have amounted to 100,000 pounds.

Perring acknowledged to the Southern Investigative Reporting Foundation that he believed Earl owed him a payment for “research services,” but Perring said he did not remember the specific amount.

After the eruption of the expense reimbursement argument (that the two never resolved), Earl thought he had heard the last of Perring.

One day by the school

Just six weeks later, however, Earl received an alarming phone call from Perring, as he later recounted to the Southern Investigative Reporting Foundation. On Dec. 6, 2016, about an hour after Earl had posted a critical analysis of Wirecard on his blog, Perring phoned, saying he had been held against his will right after dropping off his daughter at school, Earl later alleged. Two large men with Eastern European accents had forced their way into Perring’s car that morning and demanded he tell them everything he knew about Earl and Zatarra’s short selling of Wirecard stock. They also, Perring said, wielded pictures they had recently taken of Perring’s family and threatened that they would return in two days: If he did not cooperate then by telling them everything he knew about Earl, Zatarra and the Wirecard shorting, they would hurt him. If he fully cooperated, however, they would pay him 100,000 pounds.

As Earl later recalled, he was virtually speechless: “I was stunned, and all I could do was think to ask him about the police and what were they doing to protect him and his family.”

Yet the more he thought about it, Earl found the tale profoundly strange — that thugs would threaten Perring to obtain information about a man with a fairly high profile, about whom much information was publicly available. Nor did it escape Earl’s notice that the sum of money allegedly offered Perring was was identical to the amount Earl had refused to pay him.

Later that day, Earl called the Lincolnshire Police Department and spoke to the detective chief inspector who had fielded Perring’s complaint about the purported abduction. That call was brief and dull, with the inspector making it clear to Earl that the matter was not a priority for him and he lacked information because there really wasn’t much information to give out.

Whatever misgivings Earl had about Perring’s account, this was not the police response he expected to a claim that thugs had detained and threatened harm to someone in broad daylight right outside a school zone.

Further attempts to gain more information from the inspector ended the same way — with comments like “there isn’t much to say because not much happened.” And other public safety units contacted by Earl did not have any additional information.

While nothing came of the alleged threats to Perring, Earl said at least one aspect about the whole incident rang true to him: At the time, Wirecard was indeed deploying private investigators to surveil both Perring and Earl, according to Earl. “It wasn’t particularly pleasant — cars parked outside of your house at all hours, photographs being taken, friends asking you why someone was ringing them up about you,” Earl recalled. He added that two men from Kroll had delivered to his home a threatening letter from Wirecard’s lawyers.

Several other hedge fund managers who had shorted Wirecard’s stock in the summer of 2016 told the Southern Investigative Reporting Foundation that they observed similar surveillance operations against them and had received legal threats from Wirecard. They shared documents and provided recollections of this activity to the Southern Investigative Reporting Foundation but asked to not be named.

A Wirecard spokesman, FTI Consulting’s Charles Palmer, wrote in response to Earl’s allegations, “Wirecard strongly denies Mr. Earl’s claims. Wirecard, has not, at any point, instructed any third-party to surveil him.”

In a response to a question from the Southern Investigative Reporting Foundation, Perring maintained that the confrontation had transpired exactly as he had initially described it to Earl: “Your question belittles the very serious nature of the crimes that took place against me and my daughter,” he said. “There were several witnesses who came forward following my abduction and an arrest was made. Equipment was seized from the arrested individual.” Perring continued, “Likewise independent witnesses reported the occupants of the car’s suspicious activity. There are other events I cannot currently disclose.”

The Southern Investigative Reporting Foundation inquired with Lincolnshire Police’s media services office about the alleged assault. Lincoln Police Officer Lisa Porter, in an emailed response, wrote that following Perring’s complaint, police had arrested a man on Dec. 6, 2016, but he had been released without any further action taken and the case was now closed.

In a follow-up email, Officer Porter clarified that “without any further action” meant that no charges were filed against the arrested man. She added that documents about the incident were not publicly available and declined to answer numerous questions about the identity of the arrested man.


Last summer Perring shared a rather unusual WhatsApp message with Fahmi Quadir. In it, he had a note directing his London-based lawyer Dina Shiloh to issue a press release on July 29 that would declare Perring is giving up his public profile because his “pseudo faux public existence” involved misleading those whom he “cares most about” and he does not wish them to be “criticised or trolled for supporting him.”

In September Quadir told the Southern Investigative Reporting Foundation she had remained close friends with Perring despite their having ended their romantic relationship several months earlier. Quadir said she suspected what had prompted Perring to send the message was her recent confrontations with him in May and June about alleged lies he had told her.

Shiloh never put out the press release and it’s unclear if Perring even sent the note to her. In an email reply, Shiloh said all questions should be addressed to Perring.

When asked to comment on the context of his message to Quadir, Perring wrote that he believed the Southern Investigative Reporting Foundation was acting with “malicious intent” in “disclosing [his] personal messages.”

Perring also said he had never shared any messages “that would have damaged [Quadir’s] business or personal image.”


The reporting in this article, accomplished with a trip to England, was drawn from interviews with 15 portfolio managers and research analysts who have dealt with Perring over the past four years. Many of those interviewed provided corroborating documentation, including emails, notes, and screen captures of texts and comments on encrypted messaging services.

Given the sensitive nature of Fahmi Quadir’s relationship with Perring, this article selected only the information that was backed up by documents. In Earl’s case, this article used only his statements that were supported by documents and corroborated by another person.

Perring’s responses included a series of ad hominem attacks that were completely outside of the scope of this article, and because of this his full set of responses were not included. He chose to not reply to five final questions, terming this investigation “a charade.”

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A Short Foray Into Social Service

After the Lincolnshire County Council hired Fraser Perring to work as a social worker, in January 2011 he began an assignment on the East Lindsey family support and assessment team.

His nearly 19-month tenure with the team (which ended badly for both Perring and the council) involved elements of denial and allegations of dishonesty that have also been suggested in his Wall Street career.

On June 13, 2012, two Britons lodged a serious complaint against Perring: The aunt and uncle of a child whose care he was overseeing accused him of failing to properly notify them of the council’s intent to proceed with a closed adoption for their nephew. A closed adoption, which is now rarely performed in the United States or Europe, allows a birth family little contact with an adopted child’s new family; the practice is considered a “last resort” as a matter of British policy, according to a later investigation of Perring’s actions.

During the council’s investigation of the allegation, Perring insisted that he had followed all procedures, made three phone calls to the child’s relatives and sent them an April 17, 2012, letter that discussed the adoption recommendation. The investigators, however, concluded otherwise.

Records on the council’s server showed that the letter Perring claimed to have sent in April had been created on June 20, 2012. And phone records showed that Perring had not called the family from either his mobile or office phone.

During the investigation Perring appeared to not address the specific charges; he instead chose to decry what he called a toxic office culture and an excessively large caseload. He submitted his resignation on June 27, 2012.

But Perring did not leave his job empty-handed: After bringing a claim before the Nottingham Employment Tribunal, in July 2013 he secured from the council a 24,000-pound settlement, which did not admit his allegations of breach of contract and wrongful dismissal. Ghazan Mahmood, Perring’s lawyer in the proceedings, did not reply to an email seeking comment.

In February 2014 the Health and Care Professions Tribunal Service conducted disciplinary hearings on the matter and upheld the council’s findings. (Perring did not attend the hearings.) The tribunal service revoked his social worker license and designated him as “struck off.” The service is the adjudication arm of the Health and Care Professions Council, the United Kingdom’s primary licensing body for health care and social work professionals.

The tribunal service’s decision provided the following scathing indictment of Perring’s conduct before and after the episode: Perring’s “response shows that there is a complete denial of the serious issues that have been proven against him and that he has shown no insight whatsoever. Instead he sought to blame others, the management culture and has avoided dealing with the issues.”

Some six years later after financial journalist Gary Weiss called Perring a “scumbag” in a tweet about his social work career, on Jan. 20, 2018, Perring started publicizing his version of what happened in Lincolnshire County via 21 tweets: Perring framed the council’s handling of his case as retaliation against a “whistleblower” (Perring) — for his supposed calling out of “two senior employees” who had placed the child in an abusive environment that required the youngster’s removal. And he alleged that the council had intimidated witnesses and destroyed exculpatory documents he could have used in his defense. To top it off, Perring also claimed that he had been a victim of sexual harassment.

A call to the Lincolnshire County Council seeking comment about Perring’s latest allegations was not returned.

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Editor’s Note About Fraser Perring

It is unusual for an investigative reporter to reveal his sources, but to set the record straight I am acknowledging that Fraser Perring was a source in some of my previous Wirecard AG reporting. Earlier this year, Perring provided me with a set of documents I used in an article and he connected me to several other individuals that aided additional Wirecard reporting. Perring was not a key source whose information my reporting hinged on. By the time I was introduced to him in late 2017, I had been investigating Wirecard for months and I did not use any of the information he sought to provide in my first article on the company in January 2018. But he did talk with me frequently and did introduce me to someone whose research proved quite valuable.

As a reporter who over the years has drawn abundant legal threats and who in 2018 came within 24 hours of having to stand in contempt of a U.S. attorney’s subpoena (for refusing to provide testimony and notes for a trial), I am all too familiar with having to protect the origins of information I have obtained.

To be clear, I never told Perring the Southern Investigative Reporting Foundation would protect his identity, and he never asked for this.

For a reporter, ordinarily if a source becomes suspect, simply ignoring this source is the wisest course. When I began to suspect that I was regularly being given incomplete or misleading information, then I felt my options had dwindled.

(Indeed in 2013 I wrote about someone who, earlier in my career, had served as a source for me: Bryan Caisse, a mortgage-backed-securities portfolio manager. I wrote about him after I learned he had been running a Ponzi scheme and, to do so, was using my 2008 article about him.)

Moreover, a journalism nonprofit designed to bring a measure of illumination to the capital markets should not ignore stories that make short sellers and other financial skeptics feel uncomfortable even though they form a significant part of its readership and donor base.

In other words, accountability journalism has true meaning only to the extent that everyone is kept accountable.

Clarification: The first paragraph of this disclosure was updated on Nov. 15 to better describe when Perring provided Roddy Boyd information that was used in his Wirecard AG reporting. 

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The Pity of Wirecard, Part II: Bezzle Never Sleeps

Illustration: Edel Rodriguez
Illustration: Edel Rodriguez
Illustration: Edel Rodriguez

If questions about the integrity of Wirecard AG’s accounting in its crucial Asian operations are ever to be resolved, Singapore regulators will need to step back and take a long, hard look at James Henry O’Sullivan’s relationship to the Aschheim, Germany–based company. Prosecutors at Singapore’s Consumer Affairs Department have been investigating Wirecard’s fast-growing Asian division, claiming in a March 8 filing that employees in its Singapore office orchestrated a complex, multiyear scheme to inflate the company’s revenue.

Specifically, the regulators would want to examine O’Sullivan’s complicated role in Wirecard’s suspect October 2015 purchase of Great India Retail’s online payment businesses, which the Southern Investigative Reporting Foundation reported on in January 2018.

Forty-six-year-old O’Sullivan, a native of England but said to be currently living in Singapore, seems to keep a low profile; his name rarely shows up in legal documents or on the internet, except in filings for a series of Isle of Man–based shell companies and a Luxembourg holding company, Caireen SARL.

But sift through enough of this paperwork and a very distinctive picture of O’Sullivan emerges — that of a digital payments industry veteran with a cleverly hidden hand in nearly everything Wirecard does in Asia. And O’Sullivan is the likely owner of International Techno Solutions, one of 11transactional parties” that Singaporean prosecutors have alleged engaged in “arrestable offenses,” such as round-trip accounting and money laundering, to boost Wirecard’s revenue.

Flying under the radar may soon be a thing of the past for O’Sullivan if two Chennai, India–based brothers have anything to say about it.

Ramu and Palaniyapan Ramasamy, the founders of Hermes Tickets and Great India Technology, in March sued O’Sullivan, as well as Wirecard and its chief operating officer, Jan Marsalek, claiming they had masterminded a scheme to persuade the brothers to sell their companies under false pretenses and thus exposed them to reputational and economic harm.

(Hermes Tickets and Great India Technology are both subsidiaries of the Ramasamys’ larger company Great India Retail. And the Ramasamys used to be vocal Wirecard supporters: Ramu Ramasamy delivered the India strategy update at Wirecard’s 2016 Capital Markets Day presentation to analysts and investors.)

Anyone reading the Ramasamys’ complaint would have difficulty distinguishing between the interests of O’Sullivan and those of Wirecard since the suit has described both as pursuing an identical strategy and seeking the same assets. The Ramasamys have claimed in their suit that O’Sullivan (referred to as Defendant No. 4) approached them in early 2014 and made a bid for Hermes Tickets — through a Singapore-based company named Santego he seems to control. And though the Ramasamys declined O’Sullivan’s bid, he kept in contact with them and submitted another offer at the end of 2014, they said. The brothers turned down that one, too.

But O’Sullivan shifted gears in December 2014, according to the Ramasamys’ suit: He tried to arrange for Wirecard to invest in Great India Technology by introducing the brothers to Wirecard COO Marsalek, they said. The complaint has further alleged that O’Sullivan described Wirecard to Ramu Ramasamy as his “German partners” and told the brothers he was aware of Wirecard’s strategic deliberations as well as its management’s willingness to move rapidly to close a deal.

In October 2015 Wirecard invested 14 million euros in Great India Technology, amounting to 56 percent of its privately held shares. Separately, O’Sullivan paid 1 million euros to purchase his own 5 percent stake. Per the Ramasamy’s lawsuit, the entity that he used to purchase and hold his 5 percent investment in Great India Technology was Emerging Markets Investment Fund 1A, a Mauritius-based fund.

That same Emerging Markets Investment Fund 1A had in September 2015 paid the Ramasamys about 37 million euros to purchase Hermes Tickets. Yet six months later, the fund sold Hermes Tickets to Wirecard for 230 million euros up front, with 110 million euros in performance bonuses delivered over three years; the total price amounted to 340 million euros. In a press release and its corporate filings, Wirecard discussed its Hermes Tickets purchase at length — but without mentioning the seller, Emerging Markets Investment Fund 1A.

Wirecard has denied the Ramasamys’ allegations that it misled the brothers or collaborated with O’Sullivan. Angela Liu, an attorney at London law firm Herbert Smith Freehills who represents Wirecard, said via email, “Wirecard wholly rejects the allegations made against it by [Great India Retail.] Wirecard considers that the lawsuit has no merit and will be defending it in full.”

Liu added, “Wirecard is not aware of any role of Mr. James Henry O’Sullivan in Wirecard’s acquisition of Hermes; he did not receive any compensation from Wirecard.”

But a detail that just surfaced as result of the lawsuit’s filing might prove very damaging to Wirecard: Page 24 of Ramu Ramasamy’s affidavit submitted to the court on April 1 clearly suggested that O’Sullivan (Defendant No. 4) was either the owner or agent of Emerging Markets Investment Fund 1A (Defendant No. 3). Moreover, Ramasamy’s affidavit described O’Sullivan as having played an active role in negotiating the fund’s Hermes Tickets purchase and its two-month-later resale to Wirecard. (The fund is also a defendant in the Ramasamys’ lawsuit.)

Indeed the Ramasamys’ lawsuit has claimed that O’Sullivan used Emerging Markets Investment Fund 1A to purchase Hermes Tickets as well the 5 percent stake in Great India Technology — and to subsequently resell them to Wirecard for a substantial multiple of their original prices.

So what’s the risk to Wirecard from its Hermes Tickets deal being examined in court? Should the Ramasamys prove that O’Sullivan is an owner of Emerging Market Investment Fund 1A, a host of questions would be raised about possible improper sales practices by Wirecard. And where did that handsome sum of 340 million euros paid by Wirecard go?

While O’Sullivan might not be the sole owner of Emerging Markets Investment Fund 1A’s shares, he could not use it to buy and sell assets unless he was either a sizable stakeholder or had been given power of attorney by someone who is.

Singaporean prosecutors have stated they are investigating Hermes Tickets and Great India Technology for their possible role in Wirecard’s alleged accounting scheme. And while the prosecutors’ March 8 filing did not mention Emerging Markets Investment Fund 1A, they did name one of the fund’s key investments, Orbit Corporate & Leisure Travels, as an additional so-called transactional party potentially involved with dubious sales. (To date, the fund has invested in four companies: Great India Technology,  Hermes Tickets, Orbit Corporate & Leisure Travels, and Goomo, a consumer-focused company with a travel-booking platform that was spun off in March 2017 from Orbit.)

Though the Ramasamy brothers are seeking about 51 million euros in damages from Wirecard and the other defendants, they also greatly want information. Ramu Ramasamy’s affidavit asked the judge to compel Wirecard to disclose the particulars of its relationship with Emerging Markets Investment Fund 1A and for the fund to identify all of its equity ownership.

When queried if Wirecard knew of O’Sullivan’s efforts to buy Hermes Tickets and about his alleged stake in Emerging Markets Investment Fund 1A, Liu replied, “Wirecard was not aware of any attempt by Mr. O’Sullivan to buy Hermes in 2014 nor does Wirecard have any information that Mr. O’Sullivan is or was a shareholder of EMIF1A.” She said, “As evidenced by the share registry, Mr. O’Sullivan never was nor is the owner of 5% of the shares in GIT,” referring to Great India Technology.

Liu also acknowledged that O’Sullivan has had a longstanding relationship with Wirecard. “Mr. O’Sullivan has been in contact with a multitude of employees at Wirecard for many years; discussing a variety of subject matters, including joint customers and customer projects.”

The incredible disappearing act of O’Sullivan

O’Sullivan’s success as an operator in the digital payments sector can be attributed both to the web of connections he made in the early stages of his career as well as his aforementioned practice of keeping a low profile.

Nonetheless, O’Sullivan’s name crops up in some sparse British regulatory filings for a series of now-shuttered companies that used to be based in the tax and regulatory haven of the Isle of Man — all linked to David Vanrenen, a South Africa-born digital payment entrepreneur. One of the initial developers of what became known as the digital wallet, Vanrenen (like O’Sullivan until recently) lives in Monaco; Vanrenen’s son Daniel may have introduced O’Sullivan to him. (Visa just purchased Earthport, a cross-border payment services company that Vanrenen co-founded in the late 1990s, for $320 million.)

Starting in 2002 O’Sullivan served as chief executive of one of Vanrenen’s companies, Waltech Limited, and as a director of four of its subsidiaries. And Vanrenen’s Walpay became a leading payment processor for high-risk operators in the often shadowy but legal industries that Wirecard has long served ― ones offering pornography, internet gambling, currency exchange and binary options.

According to Bloomberg, O’Sullivan was the chief technology officer of another Isle of Man–domiciled company, Pay 2 Limited; this prepaid card issuer claimed prior to its 2009 dissolution that it processed 50 million pounds a month in transactions. One of O’Sullivan’s colleagues at Pay 2 Limited, its former financial controller Peter Stenslunde, is now executive director of Wirecard South Africa.

More recently, however, O’Sullivan has adopted a new modus operandi: He seems to have stepped away from daily corporate management duties for the most part. And in what appears to be an attempt to remove all public traces of his business ties, O’Sullivan began (especially after October 2015) using representatives to stand in for him on some corporate boards or as a company’s registered owner (so that their names not his appear in public filings).

Vanishing from Bijlipay Asia

A good example of O’Sullivan’s muted business presence can be observed with Bijlipay Asia Ltd., a holding company that began its life as a Vanrenen-controlled entity called Waltech Asia Pte. Ltd. but changed its name in 2009 after its registration in Singapore. From Jan. 12, 2009, until Oct. 28, 2015 — the day after the Great India Technology deal became final — O’Sullivan served as a director of the company. (Roy Harding, a longtime colleague of O’Sullivan from his days at Waltech Limited, departed from Bijlipay Asia’s board at the same time. Also a director of O’Sullivan’s holding company Caireen SARL, Harding resigned from its board on March 31, 2017.)

Although O’Sullivan is no longer on Bijlipay Asia’s board, his proxy is almost certainly 53-year-old Ricky Raymund Misson, who resides in Singapore. Referring to himself as audiovisual consultant and a former staff sergeant with the Singapore Armed Forces’ special operations group, Misson has an unusual résumé for someone now running several enterprises involved with multinational digital payment services.

Misson’s name appears in the database of Singapore’s Accounting and Corporate Regulatory Authority as the principal owner of four companies: Bijlipay Asia, Misson Pte. Ltd., Africa Card Services Pte. Ltd. and Santego Capital Pte. Ltd.

Bijlipay and Africa Card Services are engaged in aspects of digital payment services. Records indicate Misson Pte. Ltd. is the entity Misson relies on to manage his audiovisual consulting business. And Santego Capital is probably the holding company that the Ramasamys have alleged O’Sullivan used in early 2014 (as mentioned above) for his first Hermes Tickets bid. (The Ramasamys’ lawsuit referred to “Santego Business Corporation,” but no company with that name is listed in Singapore’s corporate registry. An individual involved in the litigation told the Southern Investigative Reporting Foundation that Ramu Ramasamy substituted “business” for “capital” when filing his affidavit.)

Misson’s Bijlipay is Wirecard’s oldest publicly disclosed customer in the Asia-Pacific region. (Its holding company Bijlipay Asia owns 95 percent of Skilworth Technologies Private Limited, a Chennai-based payments company that possesses the trademark for the Bijlipay mobile point-of-sale machine marketed in India. Another former colleague of O’Sullivan, Timothy William Johnstone, sits on Skilworth’s board.)

The Southern Investigative Reporting Foundation obtained dozens of Wirecard emails and documents referring to Bijlipay, but none mentioned Misson.

Yet, internal Wirecard documents and emails indicate that O’Sullivan is well-known to key executives in Wirecard’s Singapore office and that they clearly understand he controls Bijlipay.

For example, a Nov. 15, 2017, email thread between Wirecard Asia’s executive director, Fook Sun Ng, and Wirecard Asia financial staff (including finance director Edo Kurniawan) discussed Bijlipay’s 3.71 million euro debt to Wirecard so that Ng could then discuss the matter that evening with O’Sullivan.

A May 2018 report by law firm Rajah & Tann put Bijlipay at the center of a fraudulent accounting scheme and claimed that three years’ worth of sales and purchase agreements between Bijlipay and Wirecard’s Indonesian office were fake. (Wirecard hired Rajah & Tann in April 2018 to examine the claims of a Singapore-based whistleblower alleging that the company’s executives had committed widespread accounting fraud.)

In their March court filing, the Singaporean prosecutors named Ng, Kurniawan and four other Wirecard Asia employees as suspects in a series of potentially “arrestable offenses” in the Wirecard accounting case.

Misson did not reply to several emails from the Southern Investigative Reporting Foundation seeking comment.

Bijlipay’s CEO, Pradeep Oommen, did not respond to an email with several questions from the Southern Investigative Reporting Foundation.

And when asked about Bijlipay’s importance to Wirecard, attorney Liu said Bijilpay had contributed less than 1 million euros to Wirecard’s revenue in 2018.

Wirecard, according to its internal documents, might not realize lot of revenue from Bijlipay but it has instead contributed plenty of headaches. For example, in May 2017 Wirecard’s supervisory board wanted to see the “business case” (a standard internal assessment of probable profit and loss made by a bank before closing a commercial loan), for the $10 million loan Wirecard had granted Bijlipay in 2014. When it dawned on a group of finance executives that they had not created one, merger and acquisition manager Lars Rastede remarked in astonishment via email, “Did nobody perform a cost/income calculation before jumping into the Bijli project financed by $10 million?”

Reworking the helm at Internal Techno Solutions

Another company that succeeded (at least formally) in jettisoning the O’Sullivan name from its management and ownership structure is International Techno Solutions Pte. Ltd. Originally launched in 2003 as Walpay Asia Ltd. and based on the Isle of Man, the company in 2008 adopted the name International Techno Solutions Pte. Ltd. after registering in Singapore. O’Sullivan served on International Techno Solutions’ board from October 2008 to October 2010 and as its owner until May 2014.

This spring Singaporean prosecutors included the company as one of the cited transactional parties in their ongoing investigation of Wirecard’s accounting and sales practices.

A year before prosecutors became concerned about International Techno Solutions, Rajah & Tann had flagged as problematic a series of transactions between the company and Wirecard’s Indonesia office.

In May Singapore authorities revoked International Techno Solution’s registration in a move known as “striking off.”

The many faces of Senjo

One of the few entities O’Sullivan can still be directly connected to is Caireen SARL, a Luxembourg holding company that, in turn, owns Senjo Payments Europe SA. The latter company’s name, however, bears a remarkable similarity to that of Senjo Group Private Ltd., a Singapore-based payments company and financial technology investor described by the Financial Times in April as one of Wirecard’s three biggest customers.

Although Wirecard called this estimate inaccurate — and in May sued the paper in a German court for “making use of and misrepresenting business secrets,” according to Reuters — internal company emails from 2016 and 2017 supported the Financial Times’ reporting.

And the Ramasamys’ complaint listed O’Sullivan’s address as in “care of Senjo” at #56, One Raffles Place, the former address of Senjo Group’s Singapore headquarters.

Abigail Peters, an outside public relations adviser for Senjo Group, denied that O’Sullivan’s Senjo Payments Europe is connected to her client. In an email, Peters wrote, “No entity called ‘Senjo Europe’ or ‘Senjo Payments Europe’ has ever been part of Senjo Group.”

Peters did not directly address a question about whether O’Sullivan is a Senjo Group owner, but stated, “James Henry O’Sullivan has provided Senjo Group with consultancy services on market and investment opportunities. In that regard we have mutual confidentiality obligations with Mr. O’Sullivan. We are aware that Senjo’s relationship with Mr. O’Sullivan is not exclusive.”

But Senjo Group is closely linked to two key entities cited in either the Rajah & Tann or the Singaporean prosecutors’ reports: In a November 2017 press release, Senjo Group described as its “assets” (or investments) both Bijlipay and Mindlogicx, a Bangalore, India–based payments company.

During a January 2018 CNBC Asia interview when COO Gavin Lock was asked for details about Senjo Group, he said his company was “founded in 2016” by a “group of successful e-payment and corporate finance executives.” That skimpy overview of the organization’s labyrinthine history omitted, however, the critical role Wirecard played in funding and managing it.

What is now called Senjo Group opened its doors in March 2006 as E-Credit Plus Pte. Ltd. in Singapore. By September 2007 Wirecard executives (including COO Marsalek) were among the listed officers of E-Credit Plus’ British subsidiary E-Credence UK Limited. On Dec. 28, 2009, Wirecard purchased E-Credit Plus for 12.8 million euros, a rather steep price for a company with just 380,000 euros in revenue that year. The company was eventually renamed Wirecard Asia Pte. Ltd. and remained based in Singapore; it formed the basis for Wirecard’s rapid expansion in the Asia-Pacific region.

Discussing a move that that brings to mind the round-trip accounting charge being investigated by the Singaporean prosecutors, Wirecard disclosed in its 2014 annual report that it had “deconsolidated” Wirecard Asia Pte. Ltd. (of Singapore) so as “to optimize its organizational structure.” In other words, five years after Wirecard had initially purchased this division from E-Credit Plus, Wirecard sold it to Senjo Group’s first two listed officers: Senjo Group’s current general manager, Christopher Eddie, and its head of commerce, Yoshio Tomiie. Wirecard received a net payment of 100,000 euros for the company. (Wirecard today does maintain a division called Wirecard Asia.)

In February 2017 Tomiie sold the holding company that held his Senjo Group stake (called YO54 Holdings Pte. Ltd.) to Surajpal Singh, a real estate investor from Singapore, and Richard Willett, a 79-year-old horse breeder and wealthy retired Canadian entrepreneur who now lives on a ranch in Montana.

The Willett family’s interest in Senjo Group is managed by Willett’s son Oliver, who directs investments for Les Gantiers Limited, the Willett family’s office. Based in Monaco, Oliver Willett enjoys a close professional relationship with O’Sullivan. The two collaborated in 2014 and 2015 when O’Sullivan negotiated the Hermes Tickets and Great India Technology transactions.

Senjo Group gave the barest of replies to questions from the Southern Investigative Reporting Foundation and did not reply to a follow-up email seeking clarification on O’Sullivan’s ownership ties.

Richard and Oliver Willett did not reply to emails and phone calls seeking comment for this article.

Multiple phone calls to a contact number for James Henry O’Sullivan did not result in a response.

Ramu Ramasamy also did not reply to requests for comment.

Wirecard’s full set of responses still leaves O’Sullivan’s role a great mystery.

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The Pity of Wirecard, Part I: Oliver’s Army

SINGAPORE — Few companies can explain their meteoric growth as alluringly as Wirecard AG.

According to one of its preferred narratives, Wirecard presents itself as Europe’s leading financial technology innovator, a globe-spanning developer of white label code and applications that companies can use to help build their own online payment systems.

In Wirecard’s telling, its software removes the friction from electronic payments for both merchants and consumers. And in another narrative, it is a nimble bank, steadily generating low-risk revenue through the sale of integrated banking and credit-card processing services to businesses, and prepaid credit cards to consumers.

To date, investors have found the prospect of owning shares in a company that is simultaneously driving a technological shift in consumer behavior while growing profits irresistible. Last September, Wirecard entered the German corporate establishment when it displaced Commerzbank for inclusion alongside the likes of BMW and Bayer on the blue-chip DAX index, a closely followed roster of 30 of Germany’s biggest companies.

By late January, Wirecard’s market capitalization was almost 24.6 billion euros.

And on Jan. 30 that all changed, perhaps forever.

That’s the day the Financial Times published an exposé detailing a Singaporean law firm’s investigation of a host of alleged accounting irregularities in Wirecard’s Asian operations, and its stock price was pummeled. A German regulatory intervention that banned short selling of Wirecard’s shares through April 18 (a clear indication that the company’s tale of a short seller conspiracy had found some official support) did stabilize the stock price, but not before 10.6 billion euros of market capitalization were erased.

A close read of the May 2018 preliminary findings of the Singaporean law firm, named Rajah & Tann, suggests that a significant percentage of Wirecard’s success in the Asia-Pacific region — the most striking component of its growth story for the past three years — may be attributable to dubious transactions that inflated both the balance sheet and income statement. (On April 18, Wirecard, through London law firm Herbert Smith Freehills LP demanded that the Southern Investigative Reporting Foundation remove from this article a link to a document with the Singaporean law firm’s findings, arguing it does not represent a formally concluded investigation and that its publication represents a breach of the expectation of attorney-client privilege.)

On March 26, Wirecard released a statement on the Rajah & Tann report that concluded the suspect transactions would not have a material financial effect on the company’s 2018 results. It did acknowledge that “a few local employees” in Singapore might have unspecified “criminal liability” under that country’s law but no specifics were provided.

Documents obtained by the Southern Investigative Reporting Foundation show that Wirecard’s Asian success story is just that — a tale or myth fed to investors designed to propel the share price ever higher. The only thing that was keeping Wirecard’s regional operations from being exposed as a financial black hole was a single unit that Wirecard desperately wanted to keep concealed.


Meet CardSystems Middle East FZ LLC, a tiny, Dubai-based entity with a long name on Wirecard’s ever-expanding organizational chart. Don’t waste time looking for information on CardSystems in Wirecard filings. Apart from a few very brief mentions in annual reports, there’s no other reference by Wirecard.

CardSystems built a complex ecosystem of payment processors and banks that economically girds a series of gambling, adult entertainment and dating or companionship websites whose content is problematic enough that Wirecard decided it can’t have its name associated with them (even though it has a well-established track record of working with such content).

Moral and reputational concerns aside, any business that can succeed only when its core operation is hidden behind a daisy chain of lightly regulated banks and shell companies is probably going to cause investors a migraine one day.

Wirecard’s management has not been forthright about where its rapid earnings growth has come from. As recently as March 29 the company was telling investors that porn and gambling represented about 10 percent of its total transactions.

If Wirecard were to drop this line of business, then more than one-third of its operating profit would go out the door. This is a fact that Wirecard CEO Markus Braun does not touch upon when he makes speeches about the importance of optimism to Europe’s digital business community.

CardSystems essentially functions as a veiled middleman, linking various pornographic and gambling content providers to a network of payment processors and so called acquiring banks. Many of the payment processors operate behind a series of fake websites of the sort described in a June 2017 Reuters investigation.

(A brief aside: Deutsche Payment, one such payment processor that used a network of fake websites to mask illegal offshore gambling transactions, appears to have been controlled by Wirecard, which owned its trademark. According to the Internet Archive, for many years the Deutsche Payment website redirected visitors to Wirecard Austria’s site. Wirecard did not disclose the corporate connection but removed the Deutsche Payment link from its website shortly after the Reuters article was published.)

In return for this matchmaking, CardSystems receives an agreed-upon cut of the payment processing fee.

With this network in place, Wirecard can maintain a legal and reputational distance from what executives in its Alscheim, Germany, headquarters call “emotional content,” apparently referring to the gambling and porn operations.

(Although many institutional investors won’t relish being even indirectly exposed to porn and gambling, processing payments for this type of subject matter is perfectly legal in many countries.)

CardSystems’ internal financial projections for 2018, obtained by the Southern Investigative Reporting Foundation, reveal it was expected to generate sales of 450 million to 500 million euros, and earnings before interest, taxes, depreciation and amortization (or EBITDA) were slated to be an eye-popping 200 million euros. (EBITDA is a frequently cited and controversial yardstick for profitability that leaves out capital expansion and financing costs.)

Based on Wirecard’s 2018 preliminary results, CardSystems may have contributed about 22 percent of the company’s revenue and almost 35 percent of EBITDA. (Wirecard executives familiar with the unit’s performance of last year said they believed that it met or slightly exceeded these targets.)

Still, that’s tiddlywinks compared with what CardSystems meant to Wirecard in 2017,  since, according to the Federal Gazette publication of Germany’s Ministry of Justice and Consumer Protection, CardSystems accounted for 126.7 million euros or slightly less than 50 percent of Wirecard’s net income.

For all its impressive sales and profits, CardSystems is practically a one-person operation. It’s the brainchild of longtime Wirecard veteran Oliver Bellenhaus, who runs it out of his home office in what is currently the world’s tallest building, the 200-story Burj Khalifa in Dubai.

Nailing down a specific number of CardSystem employees proved difficult for the Southern Investigative Reporting Foundation. Probably fewer than a dozen employees are dedicated to the unit’s business, according to current and former Wirecard officials who spoke on the condition of anonymity out of fear of litigation.

CardSystems is a gold mine for Wirecard but its structure should check almost every box on a list of things guaranteed to raise an auditor’s hackles. The first issue is the size of its revenue relative to the small size of its workforce, a disparity especially pronounced given the sheer size of CardSystem’s business. In order to have its accounts pass muster with auditors, Wirecard officials classified about 60 Dubai-based company employees as assigned to CardSystems, but in reality they were on the company’s books at a different subsidiary.

Bellenhaus has complete operational control over CardSystems and has managed to keep a few banks, primarily ones located in Eastern Europe, engaged in his referral network. This is no mean feat since most established acquiring banks have stopped processing payments connected to porn websites, given the industry’s high charge-back rates. Apart from a stray press release issued in 2010, just about the only place the 45-year-old Bellenhaus is publicly quoted or referenced is on the websites of a Latvian bank and a Vilnius law firm.

(Charge-backs differ from traditional refund claims in that they involve a consumer’s essentially going over a merchant’s head and asking his or her bank to forcibly remove funds from a business’s bank account. When they are processed often enough, the time and expense involved rapidly begin to wipe out profitability for the acquiring bank.)

Bellenhaus did not reply to an email seeking comment. And in response to a question about CardSystems’ staffing levels, Wirecard spokeswoman Iris Stoeckl disputed that the unit’s head count is small, stating that 200 sales and tech staffers work at its Middle East and North Africa hub. She did not directly address a question about CardSystems’ virtual absence from company filings other than to note, “[Wirecard] cannot disclose any additional figures beside the figures disclosed in our annual audited report.”

There’s little evidence that Wirecard’s profile in the internet’s darker corners is diminishing. Consider the recent YouTube video on which Alexis D. Vyne, a transgender adult entertainer and film actor, shows how the company processes payments for, a Canadian website popular with individuals seeking escorts and sexual services. (Over the past several months, ads placed on LeoList were linked to four human trafficking arrests in the Greater Toronto area.)

Bringing CardSystems into the daylight ought to prompt some pointed questions from investors, and one of the first orders of business should be establishing how much business is really being done by that company for Wirecard.

Some basic extrapolation suggests that without the profits from CardSystems, Wirecard’s regional income statement would be awash in red ink.

In 2017 Wirecard’s annual report stated Asia-Pacific sales and EBITDA were, respectively, 619.2 million euros and 153.4 million euros. Recall that CardSystems’ results are included within Asia-Pacific results, however. Thus, when CardSystems’ sales of 450 million euros and EBITDA of 175 million euros are deducted, Wirecard’s Asia-Pacific sales clearly lost money in 2017.

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Wirecard AG: Something Is Terribly Wrong Here

After the Financial Times published a pair of whistleblower-driven exposés that suggested some of Wirecard’s parabolic growth in the Asia-Pacific region resulted from a purported multiyear revenue inflation scheme, anyone wanting to understand the kettle the German payments company finds itself boiling in would do well to adopt the timeless journalistic maxim “follow the money.”

But where to start?

India would be a good initial place.

According to a March 11 court filing by Singaporean prosecutors, three “transactional parties” involved in questionable deals (including two Wirecard subsidiaries) are located in India. (Singapore is both the headquarters for Wirecard’s Asia-Pacific region and where the FT reported the alleged scheme had been launched.)

The prosecutors’ filing is a response to Wirecard’s motion in the high court that sought to limit the scope of the Singapore police’s commercial affairs department investigation and secure the return of computers and files taken in raids on Feb. 8, Feb. 20 and March 5. (The high court rejected Wirecard’s motion for “a lack of legal basis” but noted that the company may still appeal the decision, according to The Straits Times.)

The companies that Singaporean prosecutors are interested in — Hermes Tickets I, Great Indian Technology and Orbit Corporate & Leisure Travels — were first flagged as suspicious by the Southern Investigative Reporting Foundation’s investigation last year of Wirecard’s October 2015 purchase (for 230 million euros) of a hodgepodge of small, privately held payments and e-commerce companies called Great Indian Retail, based in India. Wirecard paid an additional 110 million euros in earnout payments through 2017.

Additional documents recently filed in India by Star Destination Management — the parent of Star Global Currency Exchange, a kiosk-based currency exchange company purchased by Wirecard — strongly suggest that the prosecutors need not go beyond India to establish that the Great Indian Retail deal stinks to high heaven.

Nothing about the deal is close to adding up.

Consider Star Destination Management’s 2016 annual report, which gives no indication that it sold its core revenue-generating asset in February 2016. Whatever else happened that year, kiosk ticket sales clearly were not too robust, and as of March 31, 2016, the company reported a loss of a little under 25,200 euros. Although Star Global Currency’s purchase price was not disclosed, the modest scale of its operations is seen in the Department of Industrial Policy and Promotion‘s foreign direct investment circular where Wirecard’s 1.45 million euro capital injection is disclosed.

Star Destination’s filings offer documentary proof that the Indian sellers of these companies have received only a fraction of the 340 million euros that Wirecard spent. In any quest to follow the money, it’s important to know where the money is not.

(Wirecard, through its outside spokesman Charles Palmer of FTI Consulting, said in an emailed comment that the company had no business relationship with Star Destination Management.)

Recall that using both corporate and governmental filings, the Southern Investigative Reporting Foundation’s reporting showed that what Wirecard purchased, Hermes Tickets I and the 60 percent stake in Great Indian Technology, cost a total of 52.36 million euros — 37.36 million and 15 million, respectively.

The gap between the 230 million euros Wirecard spent buying these companies and the 52.36 million that is observable in corporate or regulatory filings is a handsome 177.6 million euros — all before another 110 million euros was paid out to the sellers for meeting agreed-upon performance targets.

And to be sure, Wirecard’s disclosures of its cash outflows from investment activity — the section of the annual report listing what the company has paid to acquire companies or assets — in the years 2015 to 2017 indicate 340 million left its coffers.

So where did the 287.6 million euros go?

All signs point to Mauritius-based Emerging Markets Investment Fund 1A, an entity with no discernible beneficial owner that’s acted as an intermediary between the sellers of Star Global Currency and Great Indian Retail, and Wirecard. Its distinguishing characteristic is its ability to get Wirecard to buy assets for multiples of what it paid just weeks prior.

(Asked whether the prices it paid for these assets were in the best interests of shareholders, Wirecard replied via email, “The acquired asset’s valuation ultimately reflects the growth potential of the Indian payments industry and the company’s unique position in the Indian market.”)

What few details there are about Emerging Markets Investment Fund 1A’s existence serve to raise further questions.

For example, it shares the identical physical address of Emerging India Fund Management, a Trident Trust administered fund in Mauritius, a jurisdiction with minimal disclosure requirements. Additionally, an email address for Emerging Markets Investment Fund 1A found on Great Indian Technology’s private-placement document tracked back to Emerging India Fund Management. Numerous calls to Trident Trust were not returned.

Furthermore, a circular series of connections link Emerging India, Emerging Markets Investment Fund 1A and Wirecard.

(Asked about Wirecard’s relationship to Emerging Markets Investment Fund 1A, FTI’s Palmer said that the company has no “economic interest” in the fund and declined to comment additionally, given the rules limited partnerships impose on disclosure.)

Emerging India, according to press accounts, has invested $180 million in two private equity transactions: Orbit Corporate & Leisure Travels, an agency specializing in trade shows and professional conferences, and Goomo, a consumer-focused company with a travel-booking platform that emerged last March from Orbit.

Orbit’s March 31, 2016, shareholder list indicated that Emerging Markets Investment Fund 1A owned 93 percent of its shares. Goomo’s Nov. 11, 2016, Memorandum & Articles of Association listed the Emerging Markets Investment Fund 1A as its primary shareholder; a credit report for Goomo’s Singapore subsidiary recorded the fund as its owner.

One of Orbit’s two listed directors, Ramesh Balasundaram, founded and sold Star Global Currency to Wirecard. Additionally, Orbit’s shareholder list describes the company as “a joint venture with Star Group of Companies,” a reference to Star Global Currency and Star Destination. Just before Wirecard bought Hermes Tickets, according to the notes of a Sept. 12, 2015 shareholder meeting, the company was negotiating to sell its travel related business to Orbit. Just five days later however, Great Indian Retail’s owners began to sell shares of Hermes Tickets to Emerging Markets Investment Fund 1A.

A January 2018 lawsuit filed in England by Hermes Tickets’ minority shareholders claims that IIFL Wealth Management UK, a unit of Indian financial services conglomerate IIFL Holdings, advised Emerging Markets Investment Fund 1A in its purchase of their shares. The suit alleges that Amit Shah, a banker for IIFL Wealth Management UK, told the plaintiffs in a phone call that IIFL established Emerging Markets Investment Fund 1A and had raised money for it.

IIFL, for its part, argued in an April 2018 response that IIFL Wealth UK had nothing to do with the transaction and Shah’s only role was as “a go between who was a mutual acquaintance of both the claimants’ representatives and Emerging Markets Investment Fund 1A.” It said that Shah had no recollection of making statements about Emerging Markets Investment Fund 1A.

Amit Shah was unable to be reached for comment. According to a press release on Feb. 6, IIFL Wealth UK said that Shah had resigned for “personal reasons.”

(Wirecard is not named in this litigation.)

A recent claim filed in the Indian state of Tamil Nadu, apparently made on behalf of an unidentified Great India Retail minority investor, does name Wirecard and its chief operating officer Jan Marsalek, as well as the Emerging Markets Investment Fund 1A and  Goomo/Orbit as defendants. It appears to be one of several similar claims and while the document was not available online, the court’s web portal says that a hearing to discuss a settlement is already scheduled.

Notably, a “James Henry O’Sullivan, c/o Senjo Group” is also listed as a defendant.

O’Sullivan has several connections to Wirecard, including a stint as a director at WalPay UK Ltd., a payments company that at some point in 2012 appears to have moved to Singapore and become WalPay Asia Ltd., and is now known as International Techno Solutions PTE.

In the March 11 filing discussed above, Singaporean prosecutors named International Techno Solutions as one of the “transactional parties” doing business with Wirecard and a subject of their investigation.

Another link between James Henry O’Sullivan and Wirecard comes via Senjo Payments Europe, which he owns through Caireen SARL, a Luxembourg-based holding company. In June 2017, Wirecard’s Bank registered a lien in Singapore for the 25 million euro loan it made to Senjo Group, and that it used in financing its $30.3 million purchase of Kalixa Group, a rival payment processor.

See the full text of Wirecard’s answers to questions from the Southern Investigative Reporting Foundation.

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Corcept Therapeutics: The Company That Perfectly Explains the Health Care Crisis

If someone wanted to use a Venn diagram to illustrate what is wrong with the U.S. health care system, picking the different sets would be easy: Price gouging, abuse of loopholes, hidden risks to patients, baffling regulatory decisions, marginal efficacies and the use of doctor payments to stimulate drug sales would be some logical choices.

And a case in point would be Corcept Therapeutics, a specialty pharmaceutical company based in Menlo Park, California, and the apparent union of all things expensive and opaque. So how did Corcept, a small company with just one drug aimed at treating a tiny population of patients with a rare pituitary disorder, wind up there?

Corcept has managed to make handsome profits by quietly yet efficiently exploiting gaps in the nation’s health care regulatory framework. And its sole drug is none other than the storied mifepristone, better known as the abortion pill. While Roussel-Uclaf developed mifepristone in France in 1980, it became famous in the U.S. in 2000 when the Food and Drug Administration ruled that doctors could prescribe it to induce an abortion; it was sold as RU-486.

Just before that, two doctors at Stanford University Medical School’s psychiatry department began examining mifepristone for quite another use. In the mid-1990s Dr. Joseph Belanoff began testing a longstanding hypothesis of then-department chairman Dr. Alan Schatzberg that mifepristone could block the body’s production of cortisol and be used to help treat episodic psychosis, a condition that’s found in about 15 percent of people with major depressive disorder.

Encouraged by the results they observed in the few patients they tested, the doctors founded Corcept in 1998, with Stanford University’s technology licensing office serving as a silent third partner; the university had applied for a patent covering mifepristone’s use in treating depression.

The doctors proved adept at generating national interest for Corcept’s early-stage trial: Dr. Schatzberg proclaimed in 2002 that the drug’s potential was “the equivalent of shock treatments in a pill.

But a preliminary study of mifepristone, released in the journal Biological Psychiatry in 2002, kicked off the academic equivalent of a food fight when several veteran psychiatric researchers argued that the test results provided no statistical backing for Schatzberg’s claims. One high-profile critic told the San Jose Mercury News in 2006 that the study was an “experimercial,” or an experiment whose purpose was to generate publicity rather than meaningful results.

These critics were onto something: In 2007 Corcept halted its clinical trial for the drug’s treatment of depression and did not publish the results, a development that usually means that the findings were not positive.

Faced with the prospect of the company’s business model collapsing, Corcept’s management managed to pull off what an April 2018 Kaiser Health News article called a “Hail Mary” when it sought — and received — Food and Drug Administration approval to test mifepristone as an orphan drug for the treatment of Cushing’s syndrome.

Endogenous Cushing’s syndrome is a pituitary gland disorder whereby the body is prompted to make too much adrenocorticotropic hormone, which governs the level of cortisol. And people with hypercortisolism — who overproduce cortisol — might have their metabolic functions go awry; this could lead to a host of painful and dangerous symptoms like rapid weight gain, skin discoloration, bone loss, heart disease and diabetes.

The primary culprit behind endogenous Cushing’s syndrome is a tumor that grows on the pituitary gland; in 70 percent to 90 percent of these cases, surgery to remove the tumor can successfully address the condition, according to the Pituitary Society.

But for as many as 30 percent or so of the people with Cushing’s syndrome (individuals who can’t undergo surgery or for whom surgery doesn’t mitigate these symptoms), Corcept developed a mifepristone treatment. And on Feb. 17, 2012, the FDA approved Corcept’s application to market its mifepristone medication Korlym as an orphan drug. The label, or the official designation for what it was approved to treat, is very specific: Korlym is to be prescribed only to people with endogenous Cushing’s syndrome who have both hypercortisolism and diabetes in order to reduce side effects of hyperglycemia, or high blood sugar levels.

The fact that the FDA had granted an approval allowing the company to market Korlym, however, doesn’t mean Corcept had scientifically demonstrated the drug’s success in treating Cushing’s syndrome.

Southern Investigative Reporting Foundation readers may recall from previous reporting on Acadia Pharmaceuticals that the FDA can sharply relax evidentiary standards when confronted with a small patient population possessing a rare disease.

Indeed, the FDA approved Korlym based on a single open-label study consisting of one group of 50 patients. (An open-label study is the least rigorous type of scientific investigation.) All participants in the study knew they were receiving the drug — and not a placebo — which risked the possible introduction of bias. And the study lacked a comparison group, whose results could be contrasted with those of the drug’s recipients. Plus, 36 of the 50 study participants reported protocol violations.

The FDA’s risk assessment and risk mitigation review for this study did conclude that Korlym’s trial design was flawed without the testing of an approved comparator drug, but “the progressive and serious nature of [Cushing’s syndrome] would make it unethical to randomize any patients to placebo.”

When the company tried to expand Korlym’s sales by seeking approval to market it in Europe, other problems emerged. In March 2015 Corcept withdrew its application for Corluxin (a renamed Korlym) after receiving a final round of questions from a committee of the European Medicines Agency and declining to answer them; the company cited “strategic business reasons” for ending the process.

In a late December 2018 interview, Corcept’s CFO Charles Robb told the Southern Investigative Reporting Foundation that the reason the company pulled Corluxin’s application was “primarily commercial.”

Robb said, “We just at the end of the day couldn’t figure how we would make any money [in Europe] selling it, given the way they priced [orphan] drugs.”

The European Medicines Agency had a starkly different view of events. In a brief “question and answers” release posted online in May 2015, the agency’s committee said its “provisional opinion” was against approving the drug. Three weeks later in a more formal assessment, it cited a laundry list of concerns, including the company’s failure to control the introduction of impurities during manufacturing, the design of the clinical trial and “limited” evidence of effectiveness.

Robb did not respond to a follow-up call and email with questions from the Southern Investigative Reporting Foundation about why Corcept spent the time and money to pursue approval of its drug all the way to the last stage of the process before realizing it couldn’t make money in Europe.

Asked about the recent sharp increase in the number of deaths recorded for Korlym in the FDA’s adverse events reporting system (FAERS), to 37 in the first nine months of 2018 from 17 for all of 2017, Robb was adamant that none of the deaths could be directly attributed to Korlym. In response to a question about how he could be certain of that, he said, “All [the FAERS death reports] are adjudicated by a third party”: Robb added that Corcept retains Ashfield to provide pharmacovigilance, a service that evaluates reports of a drug’s adverse events for a manufacturer. And he insisted that the medicine and its dosage were not responsible for any of 103 deaths reported for Korlym since 2012. He did not answer a question about why 17 of the 103 death reports mentioned “product used for unknown indication.”

A brief aside: Adverse event reports are a tabulation of patient responses to a drug. The reports are unverified and are not designed to replace a formal investigation or autopsy. This completely voluntary reporting system allows for a wide array of filers, and with family members, caregivers and trained medical professionals able to make submissions, the level of accuracy and detail varies widely. Finally, many medical professionals have suggested that because this documentation is voluntary, incidents involving newer drugs are not reported to FAERS.

(To present a more nuanced view of patient deaths on Korlym, the Southern Investigative Reporting Foundation obtained longer form FAERS reports via the Freedom of Information Act. While not official reports, they do provide valuable context and data, such as dosage, basic health datapoints, initial diagnosis and the duration of Korlym use. Accordingly, any instances where the circumstances of a patient’s death suggested that a reaction to Korlym was secondary were eliminated.)

Ashfield officials did not return a call seeking comment.

Robb did, however, have a lengthy list of possible causes for these deaths: “The thing to understand is these patients are very ill. Some of them have adrenal cancer,”  he said, “Some of them ahead have been suffering from the symptoms of Cushing’s syndrome for decades; some are simply elderly and the list of medications these patients have to take can be 20 and 30 drugs long.”


Nonetheless, as Corcept’s recent income statements show, the company has certainly figured out a way to make quite a bit of money in the United States from selling this drug. Corcept’s road to success in this country has followed the tried and true specialty pharmaceutical playbook, raising a medication’s price steeply and often, while using physician speakers bureau payments to build drug awareness.

The public battering of other specialty pharmaceutical company CEOs after they tried to defend price increases might have given Corcept’s Dr. Belanoff the idea of acknowledging unpleasant facts first — before others do. Thus in April 2018 Dr. Belanoff told Kaiser Health News, “We have an expensive drug, there’s no getting around that,” perhaps in an effort to diffuse some of the sticker shock of his drug’s price tag, which he later cited as $180,000.

But that’s not anywhere close to a person’s cost for a year’s worth of Korlym prescriptions. Dr. Belanoff’s quote is only for the annual price for prescriptions of 300 milligrams, which is half the suggested 600-milligram daily dose. A more accurate yearly cost would be $308,000. And the annual expense for a patient will probably rise since, as Dr. Belanoff noted in a recent conference call, Corcept expects the typical prescription to eventually be 730 milligrams daily, the dosage explored in the FDA study.

Taxpayers are playing a growing role in Corcept’s expansion plans. According to Medicare Part D coverage data, in 2016 (the most recent year for which statistics are available), the government forked out $23.1 million for 1,086 prescriptions in the United States, a steep increase from 2015’s $11.4 million expenditure. All told, Medicare Part D payments accounted for just slightly more than 28 percent of Corcept’s revenue in 2016, a jump from 14 percent in 2015.

Medicare Part D and the Department of Veteran Affairs records are the only two sources for the general public to search for details about who prescribes Korlym. People who rely on private insurers place their orders through a single specialty pharmacy, whose sales are not reported to prescription-monitoring services. According to Medicare Part D payment records, 44 doctors each wrote at least 11 Korlym prescriptions in 2016. (The Centers for Medicare & Medicaid Services doesn’t release the names of doctors writing 10 or fewer prescriptions.)

Eleven of the 15 doctors who are the most frequent prescribers of Korlym to Medicare Part D enrollees received at least $7,500 in speakers bureau payments from Corcept in 2016 and 2017 combined. (The centers’ Open Payments Data portal lists payments only to medical doctors and not physician assistants; its data for 2018 will be released in May, along with 2017 Medicare Part D data for Korlym.)

A savvy observer might suspect that Corcept is using its speakers bureau program to compensate doctors for prescribing Korlym.

To be sure, the concept of a speakers bureau is a fully legal, well-used strategy employed by many pharmaceutical companies. Done by the book, these programs serve both marketing and educational purposes: Doctors are compensated for their time in preparing presentations and discussing their experiences of administering a medication to their patients, and other physicians can hear a discussion about the drug at a level of sophistication that a sales representative would be hard pressed to match.

But in practice, as the Southern Investigative Reporting Foundation found after its investigation of Insys Therapeutics, speakers bureau programs (if not carefully monitored) can devolve into frequently questionable, if not illegal, quid pro quo inducements.

Note: PA refers to physician assistant. Source: Centers for Medicare & Medicaid Services
Note: PA refers to physician assistant. Source: Centers for Medicare & Medicaid Services


Another thing that stands out in the list of high-volume Korlym prescribers is their peculiar geographic clustering. Cushing’s syndrome is a rare disease. The FDA has estimated that the number of people in the United States who could be prescribed this drug is 5,000. So some medical experts might be surprised to see Korlym prescribers found mainly in small towns and modest-sized cities, many at a substantial distance from established medical research centers. (For example, Dr. John C. Parker, a Wilmington, North Carolina–based endocrinologist, wrote at least 41 Korlym prescriptions in 2016. But one would have expected instead that some larger-volume prescribers would be located, say, in the state’s heavier populated Durham and Chapel Hill area, where two pituitary disorder clinics are affiliated with prominent university hospitals. Wilmington, though, is about 2.5 hours by car from these clinics.)

Could these doctors based in smaller communities with a limited pool of patients to draw from be prescribing Corcept to patients merely with diabetes — instead of endogenous Cushing’s syndrome?

When Corcept’s CFO Robb was asked during the late December interview if his company was using its speakers bureau program to encourage doctors to prescribe the drug for off-label uses, he said the company was doing no such thing. He argued that the FDA’s estimate of 5,000 U.S. patients who could potentially take the drug was somewhat arbitrary and nearly seven years old. He said that a better figure, based on research by Corcept and Novartis, is closer to 20,000. (Novartis is in the late stages of testing its own Cushing’s syndrome drug.)

In addition, Robb said that as awareness of Korlym grows, doctors will realize that more of their patients have Cushing’s syndrome, and the clustering of Korlym prescribers in smaller communities happened only because one group of physicians recognized earlier than their colleagues how the disease could be treated.

Pressed on the unusual odds of so many prescriptions for a treatment of such a rare disease from doctors in Zanesville, Ohio and Murfreesboro, Tennessee, Robb declared that “over 90 percent” of all Korlym prescriptions were “on label.” He added that “since it’s an expensive drug,” nearly all commercial insurers have an extensive preapproval process before paying for the drug.

Speaking more generally about Corcept’s marketing efforts, Robb said a company has a lot of work to do when selling a medicine for a rare disease like Cushing’s syndrome. “It is just not the case that you can walk into a doctor’s office, drop off some brochures and come back later and suddenly they’ve got a Cushing’s syndrome patient. It takes five to seven visits” for physicians to become aware of the disease, he said.

“I know the meal [served during the presentation] is modest,” Robb added. “It’s held at your local Holiday Inn or whatever and it’s entirely compliant with the PhRMA code.” The code he referred to is a set of voluntary ethical guidelines for drug companies adopted in 2002 by the Pharmaceutical Research and Manufacturers of America, frowning on sales representatives using gifts to doctors or providing them meals or entertainment as a means of drumming up business.

“We’re not flying people to Hawaii to hear about our drug,” Robb said.

Robb’s full-throated defense of Corcept’s business practices would make more sense if not for the company’s relationship with Dr. Hanford Yau. An endocrinologist, Dr. Yau sees patients at an Orlando Veterans Administration Medical Center’s clinic.

According to records obtained by the Southern Investigative Reporting Foundation, Yau and his colleagues at the VA clinic prescribed Korlym for 84 people from early 2016 to Sept. 1, 2018. Yau wrote 27 of the prescriptions. A back of the envelope calculation, using 2017’s sales and prescription volume, illustrates how important the clinic is to Corcept: VA records from that year reveal that 50 people began taking Korlym through prescriptions written by the clinic’s doctors. With their medication costing the then-prevailing price of $290,304 a year (or $24,192 a month), these 50 patients generated more than $14.51 million in sales, or 9.1 percent, of the company’s $159.2 million in 2017 revenue. (Of course, some of those taking the drug in 2017 might have started only in the middle of the year. And the figure excludes patients who had already begun taking Korlym in previous years and stayed on the drug.)

Moreover, just as his clinic had become so central to Corcept’s economic well-being, Dr. Yau became the company’s leading recipient of speakers bureau payments. In 2017 he received $95,139 from the company — over 12 percent of Corcept’s total payments to medical professionals — a more than sevenfold increase from 2016’s $13,524, according to the Centers for Medicare & Medicaid Services’ Open Payment Data portal. (But in 2014 and 2015 combined, Yau was paid just $4,610.) The second leading recipient of the company’s speakers bureau cash in 2017 was Dr. Joseph Mathews of Summerville, South Carolina, who was paid $73,777.

None of these payments were for research purposes, according to the Open Payments Data portal. Nor does Dr. Yau’s name surface on, the U.S. National Library of Medicine’s database of public and private clinical studies.

Asked several times about this doctor’s relationship to his company, CFO Robb would speak only in broad terms about the speakers bureau program’s goals without discussing Dr. Yau. He did not answer a follow-up question sent via email. And Dr. Yau did not reply to a phone message or email.

Through a Freedom of Information Act request, the Southern Investigative Reporting Foundation obtained emails between Dr. Yau and Corcept that show he was working with an Italian endocrinologist and another VA colleague to create a white paper for marketing Korlym to “community physicians.”

The expectation for a peer-reviewed medical journal article is that an investigator’s research is conducted independently from consultations with a drug’s manufacturer. But the emails obtained through the FOIA request, as shown in the image below, show that Corcept was entirely in control of this project conceptually and editorially. (The image also reveals where the VA redacted the name of the person directing the project for Corcept and other related identifiers.)

In addition, the fact that the Orlando VA Medical Center generates so many Korlym prescriptions is rather curious. The patient base of the VA’s medical system nationwide has in recent years been more than 91 percent male, according to the department’s analysis of those using its services from 2006 to 2015. But Cushing’s syndrome typically occurs in women rather than men, by an almost 5-to-1 ratio, according to the National Organization of Rare Disorders.

Susan Carter, a VA spokeswoman, did not reply to several calls and an email seeking clarification about Dr. Yau’s prescribing of Korlym and compensation for serving as part of Corlym’s speakers bureau.

Update: This story has been amended to include two paragraphs discussing the natural limitations of the FDA’s Adverse Events Reporting System and the Southern Investigation Reporting Foundation’s approach to reporting with this data.

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Myriad Genetics: This Company Has Great Difficulties Telling the Truth

In early May several hundred investors, doctors and brokerage research analysts attended a dinner presentation after cocktails offered by the leadership of Myriad Genetics in Manhattan’s midtown. Salt Lake City–based Myriad, best known for its hereditary cancer tests, was in New York to tout new research on its increasingly popular GeneSight product during the American Psychiatric Association’s annual conference.

The APA conference is an important event for Wall Street as well as pharmaceutical companies because of the massive amount of money Americans spend each year on drugs and therapy for treating depression. A March 2017 American Psychological Association article estimated the annual cost of treating depressive disorders at $71 billion and rising; in May Myriad said the total cost of major depressive disorder was $100 billion a year. Thus, taking notice of the latest drug development news could potentially be very lucrative for companies and investors alike.

And following Myriad’s $225 million purchase of GeneSight’s developer Assurex Health in August 2016, managers had a story to tell about their newly acquired diagnostic test, which uses a patient’s genetic profile to guide a psychiatrist in selecting an antidepressant.

GeneSight assesses 12 different genes in a patient to rank medications according to their prospective usefulness in treating the person’s clinical depression. It is but one entry in the emerging field of pharmacogenomics, which is concerned with how someone’s genetics can affect his or her response to drugs. And GeneSight fits into a broader movement that has emerged over the past decade called “personalized medicine” or “precision medicine,” aimed at taking into account individual variation in genetic information, lifestyle and environmental factors when considering treatment options.

So as Myriad CEO Mark Capone sat with brokerage analysts at a table, Dr. John Greden, who directed a nearly six-month-long randomized clinical trial on GeneSight, crisply presented what the company touted as “landmark” research. Greden, the executive director of the University of Michigan Comprehensive Depression Center, was warmly received, especially when he emphasized data about patients’ response to GeneSight and the remission of major depressive disorder.

Adding to GeneSight’s cachet was an Oct. 1, 2015, local coverage decision by Centers for Medicare and Medicaid Services contractor Palmetto GBA guaranteeing full reimbursement of the test’s $2,000 price for Medicare patients. And if the clinical trial concluded with results showing the test’s efficacy, commercial health care plans were expected to quickly start covering the cost of GeneSight for their members.

The day after Myriad reported that its quarterly earnings had greatly improved from the period a year prior, the company’s market capitalization grew more than $319 million, when its stock price surged $4.57.

In many ways the Manhattan presentation was the perfect event, pleasing prescribers and investors alike.

Apart from a few tiny clues, nothing would have indicated to attendees that the event was just for show, a facsimile of how a major life sciences company proceeds when discussing vital research.

If Myriad had truly wanted the medical community to grapple with its research, though, it would have secured a formal slot at the conference to present Dr. Greden’s findings and take questions from guests or researchers without ties to the company.

Instead Myriad held an off-site “satellite symposium,” for an invitation-only audience largely composed of psychiatrists and primary care doctors in private practice who prescribed GeneSight as well as analysts and bankers seeking underwriting and advisory business with Myriad.

Myriad’s staging of the May session was clever in that executives could claim to have shared the trial’s findings at an APA conference, though it was just at a poster presentation, where Dr. Greden talked to whoever walked by. This is scarcely what one would expect after a study of a genetic test that a public company has repeatedly hailed as a “landmark” achievement.

The reason for the dodge might be that from a scientific standpoint, GeneSight is a bust (although it is Myriad’s most important source of sales growth.) In an 1,167-patient trial whose findings the company announced on Nov. 2, 2017, (and published Jan. 4, 2019, in the Journal of Psychiatric Research), GeneSight failed to meet its primary endpoint of demonstrating superiority over established treatments and did not achieve 23 of its 25 secondary endpoints. The primary endpoint in a clinical trial is “the main result that is measured at the end of a study to see if a given treatment worked,” according to the National Cancer Institute.

The patients whose doctors used GeneSight reported a 27.2 percent reduction in symptoms of depression; in contrast, practitioners noted a 24.4 percent reduction for those who received treatment as usual.

Though a 2.8 percent point improvement may seem (narrowly) promising for GeneSight, for psychiatrists considering treating depression among large groups of patients, this difference is statistically indistinguishable from treatment as usual; the study’s p-value was .107. In most medical trials, 5 percent is considered the cutoff for significance. After factoring in the possibility of random or experimental error, no doctor could be certain that any benefit comes from using GeneSight.

So it was a lot safer for Myriad’s stock price that Dr. Greden and company executives spoke to a carefully curated audience about why positive results for two secondary endpoints were more significant than GeneSight’s failure to attain its primary endpoint.

Little of this might be obvious to investors and analysts because Myriad has kicked up enough dust over the years that they appear to have stopped demanding straight answers.

Then again, it’s hard to blame them since Myriad’s revelation that GeneSight’s randomized controlled trial went poorly appeared only in the last paragraph of its November 2017 press release — in a discussion of $185 million in clinical milestone payments owed Assurex’s former shareholders: “That clinical trial milestone payment will not be due because this endpoint did not achieve statistical significance in the entire study population.”

A seven-month Southern Investigative Reporting Foundation investigation of Myriad’s business practices raises the following question: What is the premium an investor should pay for a company’s ability to spin ever more fantastical nonsense — and to brilliantly navigate the opaque line between required disclosure and misdirection?


GeneSight and rival pharmacogenomic tests have caused a fair bit of controversy over the past year.

In April the American Journal of Psychiatry published a critical 14-page review of “the evidence base” behind the marketing claims of GeneSight and three competitors, finding numerous problems with the tests the companies have presented to validate their products. And in July the American Psychiatric Association’s Council on Research released a statement that echoed the journal’s finding.

In May the Journal of American Medical Association Psychiatry published a two-page opinion from a trio of high-profile psychiatry researchers, Drs. Barbara Sommer, Bruce Cohen and George Zubenko, that explored the marketing of pharmacogenomic tests. They concluded that the current array of pharmacogenomic tests, which assess a small panel of about a dozen genes, are of limited use in treating major depressive disorder. As an illness, depression is simply far too complex, with a spectrum of underlying causes; many have no genetic component at all, they argued.

Dr. Bruce Cohen elaborated on his observations in an interview with the Southern Investigative Reporting Foundation. “There is no scientific basis to order [pharmacogenomic] tests at the moment; they are a complete waste of money,” he said, adding that when even companies conduct their own research to back up their marketing claims, “they do the studies wrong anyhow.” He declined to name any specific companies.

The most problematic aspect to pharmacogenomic tests is that they are aimed at finding something that simply doesn’t exist in the case of major depressive disorder, according to Dr. Cohen: “There are no genes that determine [patients’] risk [with] or their response to medicine,” he said, adding, “No small panel of genes is going to tell you whether you have most diseases, let alone depression. Schizophrenia, for example, has around 8,000 different genes associated with it.”

Dr. Cohen said he fears that doctors, who often don’t have the latest training in psychiatric genetics, are ripe targets for “company sales reps who are very pushy.” Physicians might “mistakenly” use these tests to make scientifically dubious treatment decisions, he said.

Those sales representatives will now have to be mighty pushy to market this expensive product as the prospects of insurance coverage dim. GeneSight sports a lofty $2,000 price tag, but just 15 percent of the 313,000 tests purchased last year were reimbursed at full price, with only $100 repaid for the rest. On average the reimbursement for the test was about $412.

And one brokerage research analyst — a member of a group of professionals rarely accused of skepticism — is not shying away from voicing concerns about some of these issues.

Barclays Capital U.S. life sciences tools and diagnostics analyst Jack Meehan assigned an “underweight” rating to Myriad’s shares. Formally this means that he sees the company’s stock price as underperforming relative to its peers’; informally, it means shareholders should sell their Myriad stock or avoid it altogether. He wrote that insurance plans will be reluctant to include coverage for GeneSight.

In research reports issued on Sept. 5 and Nov. 7, Meehan and his colleagues argued that GeneSight’s failed trial and critical reception by an influential subset of academic researchers pose a formidable barrier to its coverage by non-Medicare health insurance plans. Asked to discuss this research further, Meehan declined to comment, citing his company’s policy.

On Jan. 4 Meehan held a conference call about GeneSight’s trial with his brokerage firm clients and Dr. Charles Nemeroff, a University of Texas Medical School professor and a co-author of both the American Journal of Psychiatry article and the APA statement.

Dr. Nemeroff described the trial as unsuccessful. “The most salient and most important finding in this study is the fact that it’s a failed study,” he said, adding that GeneSight’s benefit for patients, as measured in the trial, “wasn’t even close to being significant.”

During this call, Myriad chose to defend GeneSight’s merits in a highly unusual fashion, however. Its director of clinical development, Bryan Dechairo, spoke up on the call 30 minutes in and after reading a prepared statement, started peppering Dr. Nemeroff with questions; he even tried to query him about a 2006 medical study mentioned in passing. Dr. Nemeroff, who had been politely answering all Dechairo’s questions, quietly informed him that the premise of his last one “doesn’t hold water.”

Two portfolio managers told the Southern Investigative Reporting Foundation that they had never seen a public company’s representative do something like this on an analyst’s client call.

That evening, Scott Gleason, Myriad’s investor relations chief and its head of corporate strategy, sent a select group of money managers and brokerage analysts an email that drew attention to what the company alleged amounted to errors in Dr. Nemeroff’s remarks. Two hours after Meehan’s call, Myriad hosted its own call and reiterated its argument that what matters most to patients is remission from symptoms of depression.

(A decade ago Dr. Nemeroff encountered controversy of his own, although it was not related to his research or views. On September, 17, 2008, Sen. Charles Grassley made Dr. Nemeroff’s undisclosed consulting arrangements with large pharmaceutical companies the centerpiece of a hearing. Emory University then removed him as chairman of its medical school’s psychiatry department. Dr. Nemeroff did not respond to several emails and a phone call seeking comment.)

For his part, Meehan, along with his colleagues at Barclays Capital, has since September raised questions following the conclusion of GeneSight’s unsuccessful trial about whether the product is worthwhile enough for doctors to rely upon. He has floated the idea that the Centers for Medicaid and Medicare could re-examine the decision to reimburse the cost of GeneSight for Medicare patients.

When the Southern Investigative Reporting Foundation contacted Dr. Elaine Jeter, who led the assessment of GeneSight for Palmetto in 2015, she said she viewed her team’s coverage approval for the product as conditioned on a successful randomized clinical trial. Asked if this was a formal condition of the Centers for Medicare and Medicaid Services’ decision or merely her personal view, she declined to answer, saying she had retired from Palmetto two years ago.

One Palmetto official who does have current oversight responsibility for GeneSight, Molecular Diagnostic Services chief Dr. Paul Gerrard, responded to a question about his agency’s initial approval like this: “In the case of GeneSight, a number of studies were done, all supporting a similar conclusion. As such, the studies reviewed in the [local coverage decision] collectively provided sufficient evidence to support the clinical utility of the test for specific uses.” He didn’t further discuss the results of the randomized clinical trial.

Myriad spokesman Ron Rogers declined to comment on a series of questions sent via email. But he felt the need to ask, “Which hedge funds [is the Southern Investigative Reporting Foundation] working for or with related to this inquiry?”

Correction: In the initial version of this article, a paragraph discussing GeneSight’s clinical trial contained an inaccurate description of the clinical significance of the results. This has been corrected and the story updated.

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Myriad Genetics: It’s Good to Have a Pal in the Senate

To recognize what Myriad Genetics is today, it’s important to understand what happened on June 13, 2013.

The day began with Myriad having a patent-protected monopoly — its 2013 income statement is a testimony to the benefits of having no rivals — and a fearsome reputation for ruthlessly enforcing its patents.

Myriad had been awarded patents in 1994 and 1995 for two genes associated with a risk for breast cancer. But by 2009 the American Civil Liberties Union and the Public Patent Foundation legally challenged this, claiming genes are naturally occurring and thus not subject to patenting and that breast cancer research was being curtailed because of Myriad’s patents. (ACLU lawyer Tania Simoncelli subsequently discussed the suit in a November 2014 TED talk.)

Late that June 2013 afternoon, the Supreme Court ruled 9-0 in the plaintiffs’ favor, with Justice Clarence Thomas writing that the act of “separating [a] gene from its surrounding genetic material is not an act of invention.” He bluntly added, “Myriad did not create anything.”

By the time Myriad’s executives arrived home that evening, the company’s entire business model had been upended, with three companies announcing their entrance into the hereditary breast cancer screening business; more followed.

Since Myriad faced competition for the first time in its existence as a public company, the only certainty in its future seemed to be declining profits. But somehow Myriad’s stock price wasn’t decimated that day; it spent much of June 13 lifted by as much as $4.50 before plummeting 5 percent by the market’s close, to $32.01. (The month concluded with Myriad’s stock changing hands to land at a figure 20 percent lower than June 13’s $33.87 opening price, but the decline was orderly and played out over two weeks.)

That June Myriad demonstrated its genius for issuing remarks that are simultaneously absurd yet legally defensible. Consider the company’s statement on the Supreme Court ruling, released on June 13 at 12:25 p.m. EDT, headlined “Supreme Court Upholds Myriad’s cDNA Patent Claims.” The decision did allow patent protection for synthetic DNA, also called complementary DNA or cDNA, but this was a mere sideshow in the multiyear legal battle over whether genes could be privately owned. (The New York Times and The Christian Science Monitor discussed the ruling in starkly different terms.)

To meet the new challenge, Myriad did two things: It went on a five-year, nearly $900 million shopping spree in a bid to diversify its business line and started pleading for help in Washington, D.C.

The latter route appears to have been the most effective one.


For most companies, gaining legislative support or regulatory breaks in Washington can take years. But Myriad found relief in six months. To be fair, it had the advantage of being headquartered in Salt Lake City, squarely on the turf of a long-serving and powerful senator, Orrin Hatch. Until his retirement last week, the Utah legislator had chaired the Senate’s Finance Committee, which oversees the Food and Drug Administration’s budget and programs, including Medicare.

And Myriad, the first company to commercialize hereditary cancer screening in the mid-1990s, needed every last scintilla of a break it could get since its business was beset on all sides. A slew of new competitors had emerged, offering genetic screening for breast cancer at prices well below Myriad’s $3,000 price tag. The hammer stroke came when the Center for Medicare and Medicaid Services announced in December 2013 that it planned to trim its reimbursement for testing for the BRCA1 gene to $1,440 from $2,795.

The point man who pressed Myriad’s agenda in December 2013 wasn’t a K Street lobbyist but rather Daniel M. Todd, a staffer for Sen. Hatch who specialized in health care finance. Todd was no stranger to working very closely with large pharmaceutical companies to draft legislation, according to a January 2013 New York Times article.

Todd pushed the Centers for Medicare and Medicaid Services to amend its plan to cut its reimbursement for Myriad’s breast cancer genetic variant test. He made enough of a racket about the issue that Jonathan Blum, the agency’s deputy administrator and a self-proclaimed veteran of a great deal of congressional meddling, detailed their heated conversation in an email to himself.

In fairness to both Todd and Myriad, the agency had unilaterally pushed through the price cut outside the “process” that Blum described Todd as being concerned about. What especially aggravated Hatch’s staff was the circumventing of the standard 30- or 60-day comment period for interested parties to weigh in on a proposed policy change. Such a comment period, of course, gives any affected company some time to reach out to its stakeholders.

Blum’s account of the pressure he claimed Todd brought to bear on him and that Sen. Hatch applied to Marilynn Tavenner, then chief of the Centers for Medicare and Medicaid Services, later emerged in Blum’s testimony in an unrelated insider trading case.

Todd, who has been paid $680,000 by Myriad since his 2014 launch of a health care–focused strategic consulting business, declined to comment to the Southern Investigative Reporting Foundation on the record.

Blum did not return calls or respond to an email seeking comment.

Tavenner, reached by phone, told the Southern Investigative Reporting Foundation she had no recollection of the lobbying incident. Her former agency’s press office did not reply to an email.

In the end, the combined efforts of Sen. Hatch and Todd proved successful: The Centers for Medicare and Medicaid Services held off on the planned cut to the reimbursement level and in April 2014 took the highly unusual step of announcing an upward “revising” of its reimbursement for the BRCA1 test, to $2,184 from $1,438.

The agency’s reversal worked out nicely for Myriad: According to Centers for Medicare and Medicaid Services data, the change in policy for BRCA1 screening resulted in almost $16.5 million more in reimbursements in 2014 and 2015.

The math involved is fairly straightforward: In 2014 the agency’s reimbursement for each of Myriad’s 14,113 BRCA1 tests administered was $506 more than it would have been if the cost cut had prevailed. This amounted to $7.14 million.

For 2015, using the same calculations, the reimbursement differential was $9.41 million.

The episode surely represents yet another example of influence peddling along the shores of the Potomac. But why would Hatch, a Republican with an almost 88 percent lifetime rating from the American Conservative Union and one who has long raised concern about rising health care costs, demand that the government pay higher prices for a test?

Following the money trail is a good way to seek answers. Since 2011 Myriad and its executives and lobbyists have sent $130,400 to Sen. Hatch, through donations to his election committees or two nonprofit foundations he’s associated with, the Utah Families Foundation and the Orrin G. Hatch Foundation.

Hatch established the Utah Families Foundation in 1990 to provide grants to civic institutions throughout Utah. The Orrin G. Hatch Foundation, founded in 2014, is raising $40 million to create a repository for the senator’s papers and an affiliated public policy institute. Both organizations have drawn scrutiny because of their practice of fundraising from the pharmaceutical and biotech industries, despite Hatch’s influence over medical policy.

Myriad’s support for Hatch while a senator can be neatly divided into two chapters: one before the intervention with the Centers for Medicare and Medicaid and the other afterward. From 2011 to 2013, Myriad gave $30,500 to Hatch’s campaign fund and his the Utah Families Foundation. But from 2014 through last year, Myriad’s support ballooned, with the company granting his campaign fund and foundations a total of $99,900; some $90,000 of that figure came in block grants of $20,000 and $25,000 to the two foundations. A representative for Hatch did not return a phone call seeking comment.

This isn’t the only benefit that Myriad has wrangled from regulators, though.

The company’s revenue seems to have been enhanced by an apparent billing loophole for reimbursement for its breast cancer screening tests from the Centers for Medicare and Medicaid.

In the United States, all medical procedures, tests and consultations at both public and private facilities are documented and tracked according to five-digit Current Procedural Terminology codes. When procedures and tests are introduced, evolve or fall out of favor, regulators revise these codes.

In 2014 and 2015  the Centers for Medicare and Medicaid allowed for the billing of Myriad’s breast cancer-related gene tests with CPT codes 81211 and 81213. In 2016 the agency turned to a single code, 81162, for documenting both the BRCA1 and BRCA2 tests, that were jointly reimbursed for about $2,253.

Marketplace dynamics and technical advancements have resulted in practitioners offering tests that screen for a large panel of genetic variations associated with many different types of cancer. The many entrants into the genetic testing field have created somewhat of a price war.

In 2017 the Centers for Medicare and Medicaid responded to this by introducing CPT code 81432 for multi-gene cancer screening, to be reimbursed at $838, as well as code 81433 for another such test, reimbursed at $542. Myriad argued, however, its multi-gene cancer panel is so different from its competitors’ that it petitioned the agency so that its tests could have a higher reimbursement.

Sources: Myriad Genetics filings and Centers for Medicare and Medicaid data

As demonstrated by the chart above, Myriad has benefited from the Centers for Medicare and Medicaid’s reimbursing an estimated $27 million over the past two years as the old 81162 code was used.

When Myriad CEO Capone was asked about this billing discrepancy at a March conference, he replied that since the Centers for Medicare and Medicaid has his company’s myRisk multiple-gene panel tests “under technical assessment,” the 81162 code will be used until the public is otherwise informed.

(A technical assessment is the Centers for Medicare and Medicaid’s process for analyzing commercial tests for accuracy and prognostic value. Former agency officials told the Southern Investigative Reporting Foundation that a standard technical assessment should be completed in less than six months.)

None of this explains why a website run by Centers for Medicare and Medicaid contractor Palmetto GBA, using the agency’s data, lists Myriad’s myRisk test as fully covered under CPT code 81432.

One looming danger to Myriad’s pricing policy is if the agency examines the much lower price for multiple-gene panel tests offered by newer players when setting reimbursement levels: Invitae, for example, offers a test for $250 and Color Genomics is selling a similar one for $199.

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Teladoc Health: A CFO’s ‘Other Life’ Worked Out Nicely (For the Ex-Girlfriend and Her Boss? Not So Much)

Work-life balance, an ever elusive goal for many American corporate executives, has been given a fresh new meaning at fast-growing Teladoc Health, a provider of on-demand medical videoconferencing.

But don’t expect to hear about generous paternity leave or a slick new gym at headquarters; this is one benefit that Teladoc Health definitely isn’t advertising.

In a nutshell, for a little over two years Teladoc Health’s chief financial officer Mark Hirschhorn, 54, was having an affair with Charece Griffin, now 30 and an employee many levels below him on the company’s organizational chart.

At the end of it, the powerful, high-profile executive stayed with nearly nary a consequence, while his girlfriend — and her boss — hit the road.


Let’s start with this relationship’s unique optics, which appear designed to give a corporate lawyer a heart attack: While Griffin was not initially a direct subordinate of Hirschhorn, when he was given the additional title of chief operating officer in September 2016, that distinction was all but erased. Moreover, during their relationship, Griffin received a series of promotions over colleagues with either more industry experience or better credentials that stunned her former colleagues. She did well enough, records indicate, that she was able to trade out of a 7-year-old Kia and buy a late model Mercedes in February 2017. (In fairness to Griffin, several of her former colleagues spoke highly of her motivation and personality. Griffin didn’t reply to repeated attempts to seek comment through phone, text and email.)

From the perspective of power dynamics, it looks even worse.

Hirschhorn, a resident of tony Larchmont, New York, has been married since 1993, and along with his other duties, is responsible for managing the crucial relationships with investors, bankers and brokerage firm research analysts that have helped Teladoc Health raise nearly $1.3 billion in capital since March 2015. In turn, that money has enabled almost $625 million worth of recent acquisitions, which is driving the rapid revenue growth so beloved by money managers.

Accordingly, Hirschhorn has been well paid. (Hirschhorn did not reply to several voice messages left at his residence, nor to a pair of emails.)

Griffin, in a blunt contrast, is a single mother of two children who did not attend college and joined the company in May 2014 when Teladoc Health purchased Ameridoc. Working out of the Lewisville, Texas, office, she was in the unit that identified and enrolled doctors and nurses for its provider network. Former colleagues pegged her income as topping out at about $125,000.

With a tangled backstory like that, common sense suggests that the relationship be kept as low key as possible.

That’s not how it happened though: Griffin, according to her former colleagues, openly discussed her relationship with Hirschhorn. And if those co-workers initially harbored doubts about whether their CFO was really rendezvousing with Griffin, they were put to rest when Hirschhorn sent flowers to her desk after some of his Lewisville visits.

(Lewisville, about 25 miles north of Dallas, is where Teladoc Health’s non-executive operations are located, and thus given Hirschhorn’s dual COO and CFO role, he visited frequently.)

It appeared to have been a standard office romance — as familiar to many in real life as it is on TV — with them emailing each other, talking on the phone, going to dinner when Hirschhorn was in town; he even took her to Las Vegas for a few days. Except this was between perhaps the most important man in the company and a woman who, at least at the beginning of their relationship, was barely a mid-level employee.

There was one other aspect to their relationship that struck Griffin’s ex-colleagues as unusual, with very good cause: Griffin told them she and Hirschhorn liked to trade Teladoc Health’s stock together. More accurately, after Griffin received a stock grant, Hirschhorn would tell her when he thought there were good opportunities to sell some shares. His track record, she proudly told colleagues, was pretty good.

Unsurprisingly, this struck many of Griffin’s then-colleagues as massively unfair. As such, one after another they marched into the office of Amy McKay (she was Teladoc Health’s ninth employee) and the executive who was the clinical director and vice president of the payor relations unit — as well as Griffin’s ultimate boss — and loudly complained.

Long aware of the relationship, and shocked at the risk Hirschhorn had incurred as a married man with kids in college, McKay told these colleagues that trading your employer’s stock based on tips from your boyfriend — and the company’s CFO — was the last straw in a situation that in her assessment had become toxic. So in October 2016, McKay drafted an eight-page document that was a timeline of the relationship — and an enumeration of the things that she and her subordinates felt were most problematic about it — and submitted it to both the legal and human resources departments.

McKay, per three of her former subordinates, was pleasantly surprised when Teladoc Health’s legal department told her they had hired an outside law firm to conduct an independent review of her claims. After its conclusion roughly a month later, word got down to McKay that the law firm had substantiated her assertions, and that swift action would be taken to address it.

It’s not hard to imagine McKay’s shock when the promised action arrived on Dec. 27, 2016, in the form of an amended employment contract for Hirschhorn, bearing two new features that he was required to abide: A prohibition from violating the employee handbook, and for a period of one year, a suspension of the scheduled share vesting awarded to him as compensation.

That’s all.

Aside from a slight change in the lightly read legal boilerplate, Hirschhorn remained unscathed, with no other public or private sanction.

Regardless of what 2017 meant for Hirschhorn’s heart, his wallet had one hell of a year, with his total compensation nearly doubling to $3.27 million from $1.21 million.

That wasn’t (literally) the half of what he made though.

Through a Rule 10b5-1 plan set up in September 2016, Hirschhorn sold or exercised Teladoc Health options equivalent to 275,000 shares for almost $7.94 million, before commissions and taxes. According to the Securities and Exchange Commission Form 4 filings that list the securities transactions of corporate insiders, he’s been just as active this year: Through Nov. 2, he unloaded another 265,000 shares, or nearly 99 percent of what he held in January, for just under $13.02 million in proceeds.

(To be sure, there’s nothing inappropriate about an executive selling his stock, especially on a scheduled plan where they have ceded control over the timing of the trades to a broker. Nor is he alone among Teladoc Health’s senior managers in selling a lot of stock —  chief legal officer Adam Vandervoort also sold most of his common stock this year, which when combined with stock options he exercised, grossed over $8.42 million, and chief executive officer Jason Gorevic, whose sales brought him more than $14.89 million.)

Amy McKay, on the other hand, would come to view 2017 very differently.

After spending months “bitterly complaining and arguing with the HR and Legal departments over the [Mark Hirschhorn] decision,” according to two of her former colleagues who talked regularly with her during this period about these conversations, McKay was fired late one morning in October 2017. She said to her former colleagues that all she was told was, “It was a business decision.” The termination came nearly a year from the day she filed her eight-page document, and adding insult to injury, corporate security escorted her immediately from the office. (Within the following two weeks, nearly 20 percent of her unit would resign; three ex-colleagues of McKay put the total as high as 30 percent.)

Amy McKay’s departure cost her the opportunity to have made a good deal of money through stock and option grants, especially given the sharp appreciation in the price of Teladoc Health’s stock over the past year. She would eventually sign a nondisclosure agreement as part of her severance package and she didn’t return numerous phone calls seeking comment. McKay still works in the Dallas area, albeit in a different industry.

Charece Griffin, in contrast, resigned quietly in late 2017 and now sells real estate in the Dallas area.

Andrew Dunlap, an Irving, Texas-based attorney who represented Griffin during the negotiation over her exit from Teladoc Health, said the terms of her severance agreement prohibit him from discussing it in any detail. He did, however, confirm his client’s relationship with Hirschhorn.

Speaking broadly about the circumstances of his representation, Dunlap said, “A settlement was the best combination of fairness and closure open to her.” He said filing a suit and going to trial could have meant a great deal of expense and stress for Griffin, and with the Dallas-Fort Worth area’s tradition of cultural conservatism and a history of racial division, he felt there was a “lot of risk” in asking a jury to side with a black woman who had been in an extramarital relationship with a rich white man.

Dunlap said he is still astonished at the accountability differential between how his client was viewed and treated, and what Hirschhorn experienced.

“After the agreement was signed and I was on my way out of the room, [Teladoc Health’s] outside counsel at Proskauer Rose told me that Hirschhorn was definitely going to ‘feel punished,'” he said. He added, “I took that to mean the company was angry about his conduct and judgement. I didn’t think she meant there would be nothing.” (Dunlap declined to name the Proskauer lawyer he was referring to.)

The aspect of the Griffin and Hirschhorn matter that Dunlap is able to talk more freely about, primarily because he says it wasn’t covered in the settlement agreement, is the trading in Teladoc Health’s stock.

“My own work led me to conclude that at the very least, this was a violation of a bunch of [Teladoc Health’s] own employee conduct clauses,” he said. “I’m not sure why they tolerated the CFO doing that.”

The Southern Investigative Reporting Foundation sought out Dr. William Frist, a former U.S. senator from Tennessee and a key Teladoc Health director since September 2014, to see what (if anything) he and fellow board members knew about Hirschhorn’s conduct. As of the time of publication, Erin Rogus, a policy advisor and spokeswoman for Dr. Frist, had not returned an email seeking comment.


Over the course of reporting this article, as noted above, the Southern Investigative Reporting Foundation made repeated attempts to contact Hirschhorn, Griffin and McKay using phone, text and email. None of them commented for this story.

To make Teladoc Health aware of the foundation’s reporting and to give company leadership a chance to comment, chief legal officer Adam Vandervoort and Chief Executive Officer Jason Gorevic were included in the emails sent to Hirschhorn. See them in two batches. The company did not reply.

Vandervoort did not return two additional phone calls seeking comment; Gorevic, reached on his cell, angrily declined to comment.

With respect to sourcing, seven former payor relations unit employees — all of whom worked closely with both Amy McKay and Charece Griffin from 2014 to the end of 2017 — provided information to the Southern Investigative Reporting Foundation through numerous interviews, as well as their notes of relevant meetings.

Because of their concern over litigation or professional repercussions, these former executives were not named in the article.

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Acadia Pharmaceuticals: This Is Not a Pharmaceutical Company

Illustration: Edel Rodriguez
Illustration: Edel Rodriguez
Illustration: Edel Rodriguez

Frequently sporting a $2 billion plus market capitalization, Acadia Pharmaceuticals brings to mind the work of Belgian surrealist Rene Magritte. His 1929 painting “The Treachery of Images” depicts a pipe with the inscription “This is not a pipe,” suggesting that an image and its meaning don’t necessarily correspond with each other.

In that vein, San Diego–based Acadia portrays itself as a pharmaceutical company but a Southern Investigative Reporting Foundation investigation has revealed that this is merely a clever facade. What lies below is a ruthless marketing entity whose pursuit of regulatory approval is best described as “loophole-centric.”

Nonetheless, in little more than two years, Acadia has gained a remarkable foothold in the pharmaceutical marketplace. The company generated $124.9 million in sales last year — a steep increase from its $17.3 million in 2016 — and its management has told brokerage research analysts to expect its revenue to more than double this year.

This is troubling since evidence is mounting that something is horribly wrong with Acadia’s sole drug, Nuplazid, an antipsychotic for Parkinson’s disease patients who experience episodic hallucinations and delusions. These are symptoms of a condition called Parkinsons disease psychosis.

In April CNN uncovered a dramatic increase in the number of reports involving Nuplazid filed with the Food and Drug Administration’s adverse events reporting system. As noted in CNN’s reporting, an adverse event report does not mean that a drug is the cause of harm, but the document is used to help track possible issues.

In the wake of CNN’s story, FDA Commissioner Scott Gottlieb took the unusual step of telling lawmakers he would order his colleagues to “take another look” at the drug. In reply to a question about Gottlieb’s statement, Acadia sent the Southern Investigative Reporting Foundation a six-page press release from April 27 that asserted the FDA had not determined the drug posed a new risk and that doctors could continue to prescribe it.

Acadia has accomplished its growth in ways that have attracted intense regulatory scrutiny for other drug companies. The questionable practices include dispensing wads of cash to doctors to incentivize prescription writing and downplaying mounting reports of patient deaths.


Central to Acadia’s marketing is promotion of the faulty illusion that Nuplazid received FDA approval like any other drug — after successfully passing a series of clinical trials and evaluations for  the efficacy and safety of its target population. But that’s not the case: Nuplazid essentially tiptoed into the market through the FDA’s equivalent of the cellar door, a legal but unusual method of entry. In other words, the mounting fatalities reported by CNN — and the spiraling costs for the drug that Medicare and private insurance payers are reimbursing — would never have occurred if Nuplazid’s manufacturer had followed the FDA’s standard drug-approval practices.

To understand what’s happened consider how Acadia and Nuplazid fit into the spectrum of the pharmaceutical industry’s efforts to combat neurodegenerative illnesses like Parkinson’s disease. According to the basics of brain chemistry, the substantia nigra pars compacta is a part of the brain stem whose key function is producing dopamine. That chemical transmits and processes signals between the brain cells that govern the human motor function, memory and the response to pleasure. Parkinson’s disease greatly diminishes the production of dopamine, and the neural pathways that carry dopamine deteriorate to a point where motion is mostly inhibited, leading to the muscular shaking and trembling that are the illness’ hallmark.

There is no cure for Parkinson’s disease, and despite prodigious amounts of medical research few therapeutic prospects are on the immediate horizon, even as a gallery of once devastating afflictions — from polio to HIV — have become preventable and treatable. This is not for want of trying: A long list of pharmaceutical companies have spent billions of dollars on research and development of various remedies for Parkinson’s disease only to be forced to abandon their efforts as clinical testing has revealed a lack of efficacy or safety (or frequently both.) A 2014 article in Alzheimer Research & Therapy pegged the failure rate at 99.6 percent (or 243 of 244) for all the trials from 2002 to 2012 for drugs to treat neurodegenerative diseases.

(Yet a 2017 medical journal article, assessing recent developments in Parkinson’s research, took the view that some cautious optimism is warranted, however.)

Since the mid-1960s treating Parkinson’s disease has typically involved prescribing levodopa, an amino acid that when taken with carbidopa can stimulate the brain’s dopamine production and restore much of a patient’s normal muscular function. But these improvements are often temporary since the disease’s progression degrades the cells storing the newly made dopamine. And taking levodopa carries complications, since an elevated level of it has been linked to episodic hallucinations, anxiety and muscle tremors — the very symptoms patients need addressed.

Standard antipsychotic drugs offer little respite since they block the very dopamine receptors that are already in bad shape. And what’s more, the FDA has issued a so-called black box warning on this class of drugs due to the elevated risk of a stroke for elderly people with dementia.

Enter Acadia’s Nuplazid. Developed in the late 1990s, the drug was designed to stimulate a subset of the brain’s serotonin receptors, or the proteins that govern memory, cognition and learning. Relying on initial laboratory results, Acadia’s management argued that the drug should be able to lessen or eliminate the episodic hallucinations.

There was just one hitch: Nuplazid, when tested on people, has been a bust from the very start. The drugmaker has had a brutal time demonstrating that the medication works better than a sugar pill. For example, Nuplazid’s first clinical trial closed in March 2007, without any posting of results. The drug’s third trial ended in March 2014 but did not indicate any meaningful statistical difference between the medication and a placebo.

Statistically speaking, a drug trial whose range of results include zero is judged to be a failure in that the drug’s therapeutic benefits are deemed to be too small to be of medical consequence.

Faced with a third failure, Acadia’s management might have decided it had reached the end of the road in trying to successfully develop the drug. But due to a provision of the Food and Drug Administration Safety and Innovation Act, however, in August 2014 Acadia was able to get Nuplazid classified as a breakthrough therapy, a status conferred on therapies with “substantial treatment effects” in their initial clinical tests.

It was a curious decision, given Nuplazid’s track record and the FDA’s plainly stated requirement for a breakthrough therapy to have “substantial treatment effects observed in early clinical development.”

For the FDA’s part, Dr. Mitchell Mathis, the agency’s division director of psychiatry products, told the panel reviewing Nuplazid in March 2016 that awarding the breakthrough designation hinged on the fact that no other FDA-approved drugs existed for treating Parkinson’s disease psychosis, as well as the frequency that these patients were being placed in nursing homes, which he called “a harbinger of death.”

More baffling still was the FDA’s willingness to assess whether Nuplazid worked based on “a negotiated evidentiary standard” that eliminated long-standing evaluation criteria.

In a November analysis, Quarter Watch, a publication of the Institute for Safe Medication Practices, flagged several ways the approval process of Nuplazid was unusual. For example, the FDA permitted the drug’s efficacy to be measured against an index of nine psychotic symptoms — as opposed to the standard 20-point scale — and the patients in the study were exclusively advanced cases (the most likely to be responsive to any drug). The agency also allowed Acadia to stage only a single trial (rather than the usual two) and to run it just in North America, where its previous results had been marginally stronger.

The physician responsible for leading the FDA’s medical review of Nuplazid, Dr. Paul Andreason, recommended against the medication’s approval, asserting there was an “unacceptably increased, drug-related, safety risk of mortality and serious morbidity.” Andreason worked for 26 years for the U.S. Public Health Service until leaving it in 2016; he spent 13 years with the FDA. His no vote was unusual in that it publicly revealed fault lines inside the division over what constitutes an appropriate level of patient risk.

Presumably, Nuplazid would not have been given a breakthrough therapy designation if the FDA’s psychiatry product unit’s leadership thought the drug was unlikely to win approval. As ProPublica recently described, over the last several years the FDA’s approach to the review process for Nuplazid and a series of other drugs has shifted to active cooperation with pharmaceutical companies in getting their drugs commercially launched — and away from serving as a strict arbiter of science and as a guardian of consumer safety.

“The FDA’s division of psychiatry usually reviews drugs with an eye towards a lifetime of use,” said Andreason, in an interview with the Southern Investigative Reporting Foundation. “We rarely saw high morbidity in something under our consideration; [Nuplazid] is the first drug where a psychiatrist has to understand life is at risk.”

Andreason’s presentation to the FDA committee, summarizing the research he conducted and outlined in the meeting’s transcript, described Nuplazid’s results as presenting a “safety signal.” Specifically, 49 of the 459 patients who took the drug on a long-term basis either died during the trial or within 30 days of its completion. This represents a fatality rate that’s higher than 10.6 percent. For the placebo group, according to the FDA’s briefing document, the figure was 1 out of 210 in a key trial. For the 901 patients who took at least one dose of Nuplazid, the associated fatality rate was slightly higher than 5.4 percent. Andreason also observed that the patients taking Nuplazid had about a two-and-a-half-fold increase in the observed risk ratio — defined as reported incidents of an infection, a patient’s deterioration in mental clarity or death — when compared with the rate for those taking the placebo.

After weighing this evidence, the panel determined there was a lack of a “pathologically unique” identifier connecting Nuplazid to the 49 deaths. And given the fact that on average people with Parkinson’s disease may live only two to four years after the onset of psychosis, the panel did not classify the number of deaths among trial participants as unusual.

Dr. Andreason did acknowledge data that pointed to some patient benefit from Nuplazid. (There were 14 reported cases of people who took Nuplazid and showed remission from Parkinson’s disease psychosis versus a single reported remission among the placebo group.) But he told the panel that the FDA’s “usual logic” would require rejecting the drug.

And Dr. Andreason had company within the FDA in expressing concern over Nuplazid’s safety. As part of the briefing document prepared for the review panel, division of psychiatric products chief Dr. Mathis wrote a memorandum noting that while the drug’s trial was considered “strongly statistically positive,” he and some of his colleagues were hesitant to accept that the reported results were indeed “clinically meaningful,” especially in light of the drug’s “toxicity” and substantial safety risk.

“‘Does this drug work and is it safe?’ are what every medical reviewer is supposed to evaluate,” said Dr. Andreason. “And my answers were ‘not really’ and ‘no.’”

He said that his recommendation to reject Nuplazid represented a statement.

“I wanted my vote to be a clear signal that our past experience had been that the FDA had not [approved drugs with this safety profile] and that by discounting this data they would be making a real policy change.”

But his views didn’t sway a majority of the panel’s members; Nuplazid gained approval for commercial use on a 12 to 2 vote.

So why did Dr. Andreason’s colleagues overlook his arguments?

“The philosophy of our health care system has changed: People and doctors are taking a different stance than 20 years ago,” Andreason said, describing the emergence of a worldview stressing the importance of family and caregiver perceptions of the quality of life for a Parkinson’s disease patient. This shift, he said, demands that doctors do everything possible to help family members with their efforts to make their loved ones comfortable.

“This is a total shift from the culture in the 1970s and 1980s where the pressure was on doctors to avoid risks to patient health,” he said. “And it’s unreasonable to think the FDA wouldn’t be aware of these pressures.”

According to the transcript of the panel’s hearing, one of the two votes against approval came from the consumer representative, Kim Witczak, who has publicly stated that her interest in the psychiatric drug-approval process emerged after her husband’s 2003 death. (In her role as head of a medication safety organization she founded in 2004,, Witczak has shared her view that a key factor in her husband’s death was several then undisclosed side effects of the antidepressant he took. She also told the Southern Investigative Reporting Foundation that Acadia complained to the FDA about her presence on the panel.)

In an interview with the Southern Investigative Reporting Foundation, Witczak explained she voted against approval because “I didn’t think it was a reasonable risk for patients given Acadia’s [presentation of] data.” She said, “And when I asked their doctors basic questions about how the company planned on preventing off-label use, they were evasive.”

Witczak continued, “For every two people who had a 50 percent reduction of psychosis, a third person had a severe reaction.” She added, “I asked [the FDA’s deputy director of clinical science], Bob Temple, if the FDA considered this a robust trial — on any level — and he said no.”

Nuplazid’s performance is suspect in another, more recent study, undertaken as part of Acadia’s attempt to gain approval to treat Alzheimer’s disease psychosis. (Such approval would be a boon for the company as a treatment for Alzheimer’s disease psychosis would represent a much larger potential market than one for Parkinson’s disease.)

In a Lancet Neurology study published in February, Dr. Clive Ballard, a faculty member and dementia specialist at Great Britain’s University of Exeter Medical School, said over a six-week period Nuplazid demonstrated “efficacy in patients with Alzheimer’s disease psychosis.“ But he neglected to point out that nearly all substantive tests on antipsychotics last 12 weeks.

In a commentary on the Ballard-led study that was commissioned by Lancet Neurology and published alongside it, Dr. Lon Schneider, bluntly dismissed Nuplazid’s prospects for treating Alzheimer’s psychosis.

“The results of this trial cannot be considered to be positive or clinically meaningful,” Schneider wrote about the 2017 study conducted at 133 nursing homes in England.

The trial wasn’t long enough, argued Schneider, a professor at University of Southern California’s Keck School of Medicine. “If the primary outcome had been specified for 12 weeks, typical of previous trials with antipsychotics,” he said, “then [Nuplazid] would have been considered as not effective.” (Ballard did state on the front page of his study that at the 12-week mark there was little difference between the drug and placebo.)

Reached for comment, Schneider said, “I’ve seen or heard nothing since the article’s release that points to [my] view being problematic.”

Yet, there’s an odd feature to the study: According to the study’s chart tracking patient responses, at the six-week point the reported results from the placebo and Nuplazid deviate. But before and after the six-week mark, the results from Nuplazid and those of placebo essentially mimicked each other, suggesting that the drug had a minimal effect on most Alzheimer’s psychosis symptoms. No explanation for this hiccup is apparent other than it being so-called noise, an artifact, or an error introduced at some point in the testing process.

The study measured results using the neuropsychiatric inventory for nursing homes, or NPI-NH scale, assigning points based on how well Nuplazid addressed standard Alzheimer’s psychosis symptoms. So the lower the score, the more favorable the reaction. For instance, if a patient’s difficulty in sleeping increased (or was unchanged) after starting to take Nuplazid, this case was assigned one point. If the sleeping difficulties improved, the score was zero.

The Southern Investigative Reporting Foundation posed several questions to Acadia about the Lancet Neurology paper — in February. The evening before this article went to press, the company provided the following response: “While we consider the findings from the study Dr. Lon Schneider referenced in the Lancet Neurology to suggest potential efficacy and acceptable tolerability of [Nuplazid] for psychosis in Alzheimer’s disease, we are currently conducting a well-controlled, confirmatory Phase 3 study in patients with Dementia Related Psychosis.”


The upshot of the FDA panel’s approval of Nuplazid for Parkinson’s disease psychosis is that the drug is selling like hotcakes despite, as noted above, the unfavorable media scrutiny and the remarks from FDA Commissioner Gottlieb.

Bet on that changing, though.

Much of Acadia’s business model appears to have been built using as a template the methods of Avanir Pharmaceuticals, an Aliso Viejo, California-based, neurology-focused company with a pair of drugs currently on the market. (Avanir is owned by Japan’s Otsuka Pharmaceuticals.) Since April 2016 Acadia has hired 26 former Avanir staffers, with 22 of them serving as sales representatives: Ten of the 22 sell the drug primarily to nursing homes and other long-term care facilities.

                                                                Hiring Binge

Sources: LinkedIn and the Southern Investigative Reporting Foundation
Sources: LinkedIn and the Southern Investigative Reporting Foundation


If the name Avanir rings a bell, it may be because CNN’s October investigation found the company’s marketing strategy was medically and ethically dubious. The company’s drug, Nuedexta, treats a condition called pseudobulbar affect, a rare side effect of multiple sclerosis and Lou Gehrig’s disease resulting in sudden, uncontrollable bouts of laughter or crying.

Instead of peddling Nuedexta to the rare neurologist whose patient was experiencing pseudobulbar affect, Avanir’s sales staff found many physicians willing to prescribe it off-label to elderly people with dementia or Alzheimer’s disease. The investigation uncovered a close connection between the upward trajectory of Nuedexta’s prescription volume and Avanir’s payments to physicians for consulting and speaking fees.

Avanir’s off-label sales strategy initially increased the company’s revenue and propelled its stock price growth, from the drug’s November 2010 launch through the end of 2016. But adverse publicity after CNN’s October story weighed heavily on Nuedexta sales last year, with its $219.4 million total being about $55 million below management’s projections.

Source: Company documents
Source: Company documents


Dig into Avanir’s quarterly filings, however, and Nuedexta’s waning prospects appear in sharper relief. In the second quarter of 2017, sales of the drug totaled nearly $64.5 million. But in the first quarter of this year, its sales declined to $49.8 million.

A Centers for Medicare and Medicaid Services warning last month to insurers “about increases in [Nuedexta] utilization that may not be readily discerned or may relate to potential fraud” is sure to accelerate this downward arc.

Yet Otsuka management’s Nuedexta sales estimate for this year (made in February in the supplement to its annual financial filings) is more than $300 million, which would represent an increase of about 25 percent over 2017’s results.

Sources: SEC filings and company documents
Sources: SEC filings and company documents


Unlike Avanir, Acadia does not have a deep-pocketed parent to absorb the potentially steep costs should regulators and plaintiff’s lawyers begin to demand answers.

One area where Acadia has hewed closely to Avanir’s script can be found in the Centers for Medicare and Medicaid Services Open Payments data.

In a word, Acadia didn’t just open up its corporate wallet for doctors: It pointed a hose and sprayed cash at them.

Source: The Centers for Medicare and Medicaid Services' Open Payments database 
Source: The Centers for Medicare and Medicaid Services’ Open Payments database


Over the six months that Nuplazid was commercially available in 2016, Acadia spent $609,556 on consulting, speaking and travel and lodging payments to 1,578 doctors: Pomona, New York, psychiatrist Dr. Leslie Citrome’s $25,690 payout amounted to the largest sum, followed by the $19,142 paid to Dr. Khashayar Dashtipour, a Loma Linda, California-based neurologist.

But what a difference a year makes.

For 2017, Acadia paid more than $8.6 million to 7,051 physicians, with 62 doctors receiving more than $50,000 apiece, and 26 receiving at least $100,000 each.

The leading recipient of Acadia cash last year was Dr. Neal Hermanowicz, an Irvine, California-based movement disorders specialist who took in $180,123, a handsome improvement over 2016’s $10,421. The runner up was psychiatrist Dr. Jason Kellogg, of Santa Ana, California, who was paid $166,259. (In contrast, the $25,690 that Dr. Citrome received in 2016, which was the biggest payout for that year, would have ranked as only the 104th largest payment to doctors if it had been given out in 2017.)

Given the fact that Acadia hired a significant number of former Avanir sales staffers, a substantial number of doctors have ended up receiving consulting payments from both Avanir and Acadia in the same calendar year: A total of 31 did in 2017, as did 29 in 2016. Out of that group, a dozen doctors took in $5,000 apiece or more from the two companies in 2017. Just six did in 2016.

Acadia’s payments in 2017, according to the Centers for Medicare and Medicaid Services’ Open Payments database, were almost entirely for consulting, save $522,935 for food and beverage expenses. (Other payment categories the centers track include “honorariums,” such as fees for lecturing to other medical professionals, or “education,” when the company covers the expense of distributing a journal article or staging a presentation at a conference.) Despite Acadia’s discussions about supporting research on Nuplazid, the company’s appetite for external or independent research sharply declined last year. It spent just $197,587 on doctors’ research projects, in contrast with its $817,613 outlay in 2016. (Avanir went in the other direction, devoting $7.61 million to research last year and $4.36 million to payments to doctors.)

Since Acadia doesn’t release Nuplazid’s prescription count, Medicare Part D data is the only way to observe prescriber behavior. To that end, overlaying Medicare Part D prescription volume from 2016 (the latest period for which data is available) against the Centers for Medicare and Medicaid Services Open Payments data for 2016 and 2017 illuminates a few things.

There’s a good deal of overlap between those who received Acadia consulting fee payments in 2016 and 2017 and the individuals who prescribed Nuplazid with some frequency in  2016. For instance, in 2016, 14 of the 25 most frequent prescribers of Nuplazid to patients covered by Medicaid Part D received “consulting fees” in 2017 worth more than $1.21 million in total.

Almost 37 percent of Acadia’s $1.21 million in consulting fee payments, or $443,014, went to three neurologists who conducted Acadia-funded studies on Nuplazid and published journal articles about their findings: Dr. Neal Hermanowicz; Dr. Stuart Hal Isaacson of Boca Raton, Florida; and Dr. Rajesh Pahwa of Kansas City, Kansas.

Pittsburgh-based Dr. Susan Baser, a leading prescriber of Nuplazid to patients paying for it via Medicaid Part D, told the Southern Investigative Reporting Foundation, “It’s the only drug addressing [Parkinson’s disease psychosis] and we’ve had positive effects in some patients.” She added, “Personally I think it’s a good drug despite the noise about adverse events that’s out there.”

Baser, who did not receive any consulting fees from Acadia in 2016 and 2017, expressed surprise at the size of the payments that some of her peers received from the company. “I work 60 hours per week. I don’t know how they have the time. I’m just too busy for any of that.”

In addition, despite its skyrocketing sales, Nuplazid appears to have had some challenges in gaining traction among the neurologists and psychiatrists who treat Parkinson’s disease and other movement disorders. According to a review of data for all Nuplazid prescriptions paid for by Medicare Part D, 2,020 doctors or other medical personnel wrote at least one prescription for the drug in 2016. (The Centers for Medicare and Medicaid Services doesn’t list the names of individuals who write fewer than 11 prescriptions, due to patient-privacy concerns.) Only 170 doctors or other eligible prescribers wrote at least 11 prescriptions.

Of those 170 prescribers in 2016, 13 were either nurse practitioners or physician assistants whose payments from pharmaceuticals companies are not included in the Open Payments system. Among the remaining 157 individuals, 70 did not receive any money from Acadia in 2017. This suggests they may not have continued to write enough prescriptions for the drug in 2017 to draw attention from the company. (Some of the 157 individuals may have refused consulting fees or honorariums because of scheduling constraints. But current and former sales staffers for pharmaceutical companies told the Southern Investigative Reporting Foundation that these businesses aggressively try to maintain long-term connections with the most frequent prescribers.)

Acadia told the Southern Investigative Reporting Foundation that less than 5 percent of Nuplazid’s prescriptions come from its top 10 prescribers.


The money behind Nuplazid is only its second most compelling characteristic. The first is the sheer number of medical issues that appear to be linked with the drug’s use.

According to the FDA’s adverse events reporting system (FAERS), from January through the end of March, 162 patients have died while taking Nuplazid. The figure is 612 since the drug’s June 2016 debut through this March. Those fatalities, however, are just part of a larger picture that suggests longer-term challenges for Acadia: Since June 2016 nearly half of the 6,800 FAERS reports refer to topics like “hallucination” or “confusional state” or “drug ineffective.”

In response to questions on the FAERS data, Acadia investor relations representative Elena Ridloff responded via email: “Based on the totality of available information, ACADIA is confident in Nuplazid’s efficacy and safety profile which remains unchanged and — as the FDA itself has stated — is appropriately described.”

These adverse event reports aren’t considered as conclusive as an official autopsy, and the fact that a patient died while taking a certain drug doesn’t mean the medication caused it. Also, this completely voluntary reporting system allows for a wide array of filers. Family members, caregivers and trained medical professionals can make submissions. So the level of accuracy and detail can vary widely. Finally, many medical professionals have suggested that because this documentation is voluntary, many incidents involving drugs are not reported to FAERS.

An analysis of the longer-form FAERS case reports — obtained via Freedom of Information Act requests — illuminates Acadia’s success at getting prescribers to order Nuplazid for patients within long-term care facilities. The majority of the adverse events for these patients involved off-label use of the drug for various dementia-related psychoses, despite the explicit black-box warning.

A notable feature of many of the individual case reports that documented a death is the brevity of the patient’s experience with Nuplazid. Given the spotty information found in many reports, though, it’s difficult to arrive at precise numbers overall. But for those case reports citing a death that also provided a time frame for the patient’s treatment with Nuplazid, exposure to the drug had been less than 90 days on average.

For example, a 75-year-old man, identified only as Case ID: 12689689, began taking Nuplazid on Aug. 3 2016. By Aug. 26 he was dead. His cause of death was listed as “unknown,” but the case report said he had been diagnosed with Parkinson’s disease dementia.

(Nuplazid, like many similar drugs, has been observed to have a mild but discernible effect on the electrical cycle of the heart’s ventricles — in a process that cardiologists call repolarization and depolarization. Think of it as being like the movement of a swing: Depolarization is when the swing goes down; repolarization is when it heads up. The measurement of the length of the time between the two is called the QT interval, or “the space between the start of the Q wave and the end of the T wave,” according to the Mayo Clinic. If the QT interval is prolonged, the possibility of an arrhythmia sharply increases.)

Some other concerns about Nuplazid can be understood through the history of Case ID: 13253142. This 91-year-old man was (despite the black box warning) prescribed the drug to treat his Parkinson’s disease dementia and psychosis. He began taking Nuplazid in November 2016 but soon stopped for a five-month period after reports of sleep disruption and a loss of mental clarity; the report isn’t clear about whether the prescriber stopped the treatment because of this. In April 2017 the elderly patient resumed taking the drug again; soon afterward medical personnel reported that he began entering into catatonic states. After a series of health problems, including rapid weight loss and the inability to swallow, he died in May 2017. (The attending physician and the patient’s son blamed factors other than Nuplazid for the man’s death, such as the poor quality of care in his assisted living facility.)

To gain a sense of how Nuplazid’s number of adverse event reports compares with other Parkinson’s disease-focused drugs, the Southern Investigative Reporting Foundation used the FAERS database to create two charts. If Nuplazid’s death rate was parallel to other Parkinson’s drugs, the explanation for it would be unlikely to be drug-related; alternately, if those taking Nuplazid died more frequently than the comparison group, re-visiting the drug’s safety profile would be logical.

The first compares the number of serious incidents and deaths reported for people taking Nuplazid with the tally of serious incidents and deaths for individuals taking nine other Parkinson’s disease medications; the time frame considered was from June 2016 through the end of this past March. The nine other medications have longer track records for the treatment of Parkinson’s disease.

                                                        Nuplazid Compared With Its Peers

Source: The FDA's adverse events reporting system
Source: The FDA’s adverse events reporting system

Reports uploaded to the FAERS database that indicate a patient died while taking Nuplazid sharply outnumbered the reported deaths of those on the nine other drugs: A total of 610 individuals died while taking Nuplazid but just 87 died while taking any of the nine other medications. Nuplazid-tied deaths represented more than 38 percent of the total number of serious incidents; but for those taking any of the other nine medications, death amounted to less than 5 percent all serious incidents.

These results cannot be interpreted as definitive: Patients taking Nuplazid are usually quite frail since they have had Parkinson’s disease for several years and might be weaker on average than the people on the nine other drugs. Additionally, newer drugs tend to draw more FAERS submissions than more established ones.

But these results certainly show Nuplazid has a radically different safety profile than other Parkinson’s disease treatments.

A second chart explores whether Nuplazid’s seemingly high level of adverse event reports is similar to reactions to another central nervous system-targeted drug, Namzaric, which was approved in 2014 for treating Alzheimer’s dementia.

A few variables are skewed in Namzaric’s favor. There is a high probability that the Alzheimer’s dementia patients who take Namzaric are frailer than the people being given Nuplazid. Also, Namzaric’s parent company, Allergan, has spent more than four years and tens of millions of dollars on advertising online and on television to raise the drug’s profile.

It stands to reason that a new, high-visibility drug like Namzaric would, if warranted, receive a great deal of adverse event submissions.

As the chart below shows though, it hasn’t: The number of reports of fatalities and adverse events associated with Nuplazid is much greater than that for Namzaric.

                                                         Nuplazid vs. Namzaric

Sources: The FDA's adverse events reporting system and the Southern Investigative Reporting Foundation
Sources: The FDA’s adverse events reporting system and the Southern Investigative Reporting Foundation

Calculating the number of deaths as a percentage of the number of adverse events associated with the rate for Namzaric is tricky because few people who took either drug did so for the same amount of time.

Fortunately medical statisticians can rely on a measurement tool called “patient years.” It is an average of how many patients have taken a specific drug over the course of a given year. For example, assume a certain drug costs each patient $10,000 a year to take and that the medication had $100,000,000 in sales. Using the patient years calculation, researchers could say that roughly 10,000 patients took the drug for one year.

For this chart each drug’s annual sales figure was divided by its retail price at the end of 2016 and 2017: Namzaric cost $4,249 at the end of 2016 — and $5,069 in 2017. For Nuplazid, it was $25,000 and $33,336, respectively. Namzaric’s patient years figures in 2016 and 2017 were 13,536 and 25,805; Nuplazid’s were 692 and 3,747.

“Deaths per patient year” is a rough statistical way of measuring patient deaths while assuming the typical patient used the drug for a full year. Epidemiologists call this “the excess death rate,” or the number of deaths above what is reasonably anticipated in a population group.

The number of patient deaths for Namzaric was a scant .0001; Nuplazid’s tally, however, was .0881 in 2016 and .1033 in 2017.

So in 2016, if 1,000 patients took Nuplazid for one year, about 88, or 8.8 percent, could be expected to die over and above the already steep mortality rate of approximately 25 percent; in 2017 the figure would rise to 103. But it would take 10,000 patients on a Namzaric protocol for a full year for a single death to result.

This is the full text of Acadia’s response to the Southern Investigative Reporting Foundation’s questions.

Editor’s note: To obtain the fairest profile of the drug histories, the Southern Investigative reporting Foundation used adverse event reports of “serious cases,” or incidents that required medical attention, and then deaths were subtracted from this total. For the death figures, only deaths reported as a prospective reaction to a drug were counted, as opposed to the higher “death cases” figure that the FDA records.

Correction: An earlier version of this story inaccurately described Nuedexta’s safety profile. It has never carried a black box warning. Also Avanir Pharmaceuticals has two drugs that are commercially available.

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Wirecard AG: The Great Indian Shareholder Robbery

Wirecard AG is the luckiest company you have never heard of.

It has the good luck of a boxer who is a master of bobbing and weaving in the ring, making it difficult for an opponent to land a punch. Prizefights, though, typically go for all of 10 or 12 three-minute rounds. Yet for 10 years a combination of short sellers, journalists and forensic research consultancies (whose clients often include short sellers) have publicized a long list of concerns about Wirecard’s operations, to little avail.

Why so much drama?

For one, Wirecard has a business model that is pure catnip to critics of every stripe.

Having emerged from a reverse merger of a struggling dot-com era call-center operation, Wirecard shifted to payment processing. But it also owns a bank, has a low-tech prepaid payment card segment and still retains an even lower-tech call-center unit, all headquartered in a small suburb 10 miles from Munich.

Wirecard is a “rollup,” primarily built through the acquisition of smaller companies at a breakneck pace: Since late 2014 it has made 11 acquisitions. Critics argue that rollups use acquired revenue to mask broader troubles with organic growth.

Moreover, Wirecard’s approach to many of these purchases could be charitably called “highly unusual,” such when it has made large prepayments prior to announcing a deal. The Financial Times reported in April 2015 that Wirecard provided different levels of regulatory disclosure about transactions, according to the jurisdiction involved. As the FT noted, a corporate filing in Singapore (where a company purchased by Wirecard was based) revealed that its assumption of 12 million euros in liabilities was really an opaque loan it made to an unspecified recipient after the deal’s completion “for the acquisition of intangible assets from a third party.” (Wirecard CEO Markus Braun told the FT, “At such owner led companies . . . sometimes you have to buy out third party shareholders, or you have to take over assets of sister companies. This is then part of the purchase price.”)

And Wirecard’s management often discloses its financial results using custom, or “adjusted,” metrics rather than following applicable International Financial Reporting Standards. While this practice is completely legal, it can inflate the appearance of earnings and cash flow figures.

Despite all this, investors are still placing their faith — and money — behind Wirecard because of its prospects for reporting the kind of growth shown in its most recent  earnings report, for the quarter that ended Sept. 30.

The slope of the stock chart below would suggest that Wirecard’s critics are against the ropes and taking so many blows that the referee might need to step in.

Source: Nasdaq
Source: Nasdaq


But lucky doesn’t equal smart for Wirecard’s investors.

After a seven-month investigation, the Southern Investigative Reporting Foundation has obtained thousands of pages of documents that suggest a minimum of 175 million euros — and perhaps as much as 285 million euros — from Wirecard’s 340 million euro purchase of an India-based payment processor in October 2015 did not go to the seller.

Making matters odder still, Wirecard’s own filings show the money left its coffers.

So where did a large chunk of Wirecard’s capital go in one of its fastest growing markets?


In the fall of 2014 corporate finance officials from JM Financial Services, a prominent Mumbai-based investment bank, received a mandate to locate a buyer for Chennai, India-based Hermes I Tickets Private Ltd., a modestly sized e-commerce company that derived 63 percent of its business from selling travel tickets.

The Southern Investigative Reporting Foundation obtained a copy of the pitch book that bankers used to market Hermes Tickets to prospective buyers. For fiscal 2015, Hermes Tickets aimed to generate 22 million euros in sales and about 3.8 million euros in earnings before interest, taxes, depreciation and amortization, or EBITDA (a standard, though imperfect, gauge of a company’s potential profitability).

The asking price was 46.2 million euros, but no buyers emerged for Hermes Tickets that fall or through much of 2015.

On Oct. 27, 2015, a deal was announced and, well, patience paid off: Wirecard purchased Hermes Tickets when it bought the payment businesses of its parent, Great Indian Retail Group, and a 60 percent stake in another subsidiary, Great Indian Technology. The transaction’s price tag was 230 million euros in cash, plus 110 million euros in prospective earnout payments over three years.

If it seems baffling that Wirecard’s deal to pick up Great Indian Retail’s payment businesses ended up totaling 340 million euros when only 13 months earlier Hermes, its primary component, had been shopped around for 80 percent less, that’s because it is. While India is a rapidly expanding economy, Hermes Tickets might have appreciated in value somewhat — but not that much. (Wirecard, for its part, argued that Great Indian Retail’s payment assets grew substantially in value in that 13-month period because of Indian GDP growth and the rapid growth of the digital payment market.)

Even with Wirecard’s history of oddly structured acquisitions, the Great Indian Retail deal sticks out, the more so since a source with Indian venture capital experience looked at Hermes Tickets’ financials in 2014 and described its payments business as being “very small.” So the Southern Investigative Reporting Foundation started to look for documents that might explain just what Wirecard had bought, and more important, where the cash went (a task greatly aided by India’s paperwork-heavy regulatory system.)

While for an American, interpreting India’s reporting format, currency and phrases can be a challenge, the sale of Hermes Tickets in Great Indian Retail’s 2016 annual report is clearly described as the “proceeds from sale of investment in subsidiary” of 2,749,940,988 rupees, or 37,365,539 euros. This is broadly congruent with the September 2014 asking price.

India’s Department of Industrial Policy and Promotion requires a company that receives a direct investment from foreigners (or FDI) to disclose the names of those involved in the transaction as well as the value. As such, the FDI circular offers a way to confirm the sale of Hermes Tickets: From October 2015 to March 2016, a buyer paid about $39 million, roughly 35 million euros, for Hermes Tickets shares.

(Wirecard denied purchasing Hermes Tickets for 37.36 million euros and said that DIPP data only shows investments from foreign entities into India, and as such, does not reflect what it paid in Mauritius.)

Someone examining this transaction might suppose that since Hermes Tickets cost 37.36 million euros, the balance of 192.64 million euros went for the 60 percent stake in Great Indian Technology.

Unfortunately for Wirecard’s shareholders, determining what happened is not that easy.

Great Indian Technology’s primary asset appears to be its ownership of licenses to operate two prepaid payment cards, iCashCard and SmartShop. (Customers pay fees so they can deposit cash at Great Indian Retail-branded kiosks and then use the cards in debit transactions.)

According to the Sept. 25, 2015, notes of Great Indian Technology’s extraordinary general meeting, Wirecard spent a total of 15 million euros on the company — through a 1 million euro cash payment up front and a 14 million euro private placement. Great Indian Technology’s annual report indicates that the company was not very active or profitable; it generated a pretax profit of 21,952 euros for the fiscal year that ended March 31, 2015.

A close read of Wirecard’s discussion of its merger activity in the 2015 annual report reveals that in addition to Great Indian Retail’s payment businesses deal, the company had also acquired Star Global Currency Exchange Private Ltd., an operator of currency-exchange kiosks and shops. (The deal’s press release referred to “StarGlobal” as “a brand,” not a standalone company.)

It’s a curious transaction.

No linkages are apparent between Great Indian Retail and Star Global Currency in public documents. Star Global Currency’s founders, the Balasundaram brothers, do not appear to own shares of Great Indian Retail, and likewise, Great Indian Retail’s founders, the Ramasamy brothers, do not appear to hold stock in Star Global Currency. There are not any listings of related party transactions between the two companies, and Star Global Currency is not referenced in the Hermes Tickets pitch book. Star Global Currency’s website does not even mention Great Indian Retail’s money transfer and currency cards.

What is not in doubt is the math: If Wirecard spent 230 million euros up front, and the combined transaction price for Great Indian Technology (15 million euros) and Hermes Tickets (37.36 million euros) was 52.36 million euros, Star Global Currency should have been worth at least 177.6 million euros.

It was not, however.

Wirecard made a 1.3 million euro investment in Star Global Currency at an implied 2 million euro valuation, according to a March 2016 share transfer form and the FDI circular. Although it was more productive than Great Indian Technology, Star Global Currency booked a small loss on its roughly 32 million euros in gross revenue for the fiscal year that ended March 31, 2016, per its annual report. Nor was the company very big — with just 20 employees, 2.95 million euros in total assets and a book value of 1.71 million euros.

All told, the Southern Investigative Reporting Foundation was able to track 54.36 million euros of the 230 million euros that Wirecard spent on the purchase of Great Indian Retail’s payment businesses, leaving 175.64 million euros unaccounted for.

Stranger still, Wirecard’s cash outflows from investment activity, as disclosed in its filings, clearly indicate that the money for the acquisitions and the 110 million euro incentive payment left its coffers.

So where did the money go? And why isn’t Wirecard alarmed about the missing funds? The answers aren’t immediately apparent.

There is one company, however, that should bear some extra scrutiny: the Emerging Markets Investment Fund 1A, a Mauritius-based fund that has served as an intermediary between the buyers and sellers in all of Wirecard’s India-related transactions.

Star Global Currency’s share transfer filing shows Emerging Markets Investment Fund 1A acting as a conduit, transferring to Wirecard a block of 504,499 shares of Star Destination Management Co. Private Ltd. (Star Global Currency’s parent company). The fund held the shares for 27 days and sold them to Wirecard at cost.

The fund performed the same role — buying stock and then selling the shares to Wirecard shortly afterward — for Hermes Tickets (the FDI circular cites three separate transactions) and Great Indian Technology.

None of Wirecard’s filings discussed Emerging Markets Investment Fund 1A’s role in its India strategy.

Foreign direct investors in Indian companies have used Mauritius-domiciled holding companies to shield their profits from capital gains taxes, but that loophole was largely closed in 2016. Regardless, Emerging Market Investment Fund 1A’s ownership of Great Indian Retail’s subsidiaries’ shares was for a few months at most; to qualify for India’s lower tax rate on long-term capital investments, an investor has to own an asset for a minimum of 36 months.

An email address and a street location listed in the contact information for Emerging Market Investment Fund 1A in Great Indian Technology’s September 2015 private placement letter provide some clues: The email address is associated with another Mauritius-based entity, Emerging India Fund Management, as is the street address.

The website of Emerging India is splashy, and it claims to manage an impressive $1.5 billion through diverse investment strategies, but good luck figuring out who works for the fund or who owns it. The fund is based in Mauritius and uses the address of Trident Trust, an administrator for hundreds of funds that adopt its address for registration purposes. Repeated calls and email messages to Emerging India and Trident Trust were not returned.

Despite Emerging India Fund Management’s claim to have $1.5 billion in assets under management, the Southern Investigative Reporting Foundation could not find any managers of India-based institutional or endowment capital with knowledge of it. There are, however, two private equity transactions that the fund has made — for Orbit Corporate + Leisure Travels, an agency specializing in trade shows and professional conferences, and Goomo, a consumer-focused company with a travel-booking platform that emerged last March from Orbit. The fund, according to the Hindu Business Line report, has invested a total of $180 million in the two ventures.

Wirecard said that other than the Oct. 27, 2015, transaction, it has never had a connection to Emerging India Fund Management and that the fund did not act as a conduit for Great Indian Retail. The company did not address a question about the fund’s ownership.

Several connections exist between the two travel companies and Wirecard.

To start with, one of Orbit’s two listed directors, Ramesh Balasundaram, was Star Global Currency’s co-founder and co-owner. Additionally, the company is described on its shareholder list as “a joint venture with Star Group of Companies,” a reference to Star Global Currency and Star Destination.

Emerging Markets Investment Fund 1A has played a key role, in founding and controlling both Orbit and Goomo, according to Indian corporate filings.

Orbit’s March 31, 2016, shareholder list indicated that Emerging Markets Investment Fund 1A owned 93 percent of its shares. Goomo’s Nov. 11, 2016, Memorandum & Articles of Association listed the Emerging Markets Investment Fund 1A as its primary shareholder and Trident Trust’s Mauritius address as its headquarters; a credit report for Goomo’s Singapore subsidiary recorded the fund as its owner.

A connection between Wirecard and Orbit was spelled out in the Sept. 12, 2015, notes of the extraordinary general meeting for Hermes Tickets’ shareholders, concerning negotiations with Orbit to sell Hermes Tickets’ travel-ticketing business. (Travel ticketing represented 63 percent of the Hermes Tickets’ sales, according to its pitch book.) No further details about that potential sale seem to have cropped up in filings.

Notably, those negotiations occurred at the same time (Sept. 17, 2015) that Great Indian Retail’s owners began to sell shares of Hermes Tickets to Emerging Markets Investment Fund 1A. Just eight days after that, on Sept. 25, Great Indian Technology’s shareholders held their own extraordinary general meeting, where the fund’s 1 million euro share purchase and Wirecard’s 14 million euro private placement were announced.

And there’s an unusual footnote to Wirecard’s purchases of Great Indian Retail’s businesses: Their auditors resign, often.

Hermes Tickets, for example, lost two auditing firms in the space of one week in August 2015, just two months prior to its sale to Wirecard: On Aug. 24 the Kuriachan & Nova firm cited its “preoccupation with other assignments,” and on Aug. 31 the V. Krishnan & Co. firm claimed it was “not being in a position to continue” as the company’s auditor.

At some undisclosed point in the ensuing months V. Krishnan & Co. was rehired, only to resign on June 15, 2016, due to a “preoccupation with other assignments.” All told, three different accounting firms resigned from Hermes between Aug. 24, 2015, and Oct. 17, 2017; V. Krishnan & Co. and Kuriachan & Nova were appointed and resigned twice, a third firm, CNGSN & Associates LLP, was appointed and resigned three times. (Ernst & Young, Wirecard’s auditor, is now the company’s accountant.)

Great Indian Technologies and Star Global Currency also had auditors resign.

Why does this matter? Auditor resignations — especially of the unexpected variety — are closely scrutinized by investors, who often worry that a company’s accountants have discovered something problematic and are giving up the traditionally lucrative audit fees to shield themselves from litigation risk.

The accounting firms did not respond to emailed questions.


Wirecard’s public relations chief Jana Tilz did not respond to questions posed in a series of email message sent before this article’s initial publication.

But on Jan. 24 the company’s investor relations manager Iris Stoeckl and outside public relations adviser Elliot Sloane of FTI Consulting sent responses and Wirecard also made additional comments.

Update: This article has been updated throughout to include Wirecard’s replies to questions posed several weeks ago. The answers are hyperlinked as well at the bottom of the story.

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DaVita Inc.: Warren and Charlie’s Excellent Insurance Gambit

Veteran card players pride themselves on their ability to discern what’s known as “the tell,” a series of involuntary mannerisms that can betray a rival’s strategic deceptions and even suggest a possible next move.

On rare occasions a tell metastasizes into a red flag, a clear indication that something is terribly wrong.

An example of the first is buried deep in a transcript of DaVita Inc.’s annual “Analyst/Investor Day” presentation in New York City.

These meetings were once a love fest for Kent Thiry, the kidney care provider’s colorful chief executive officer, with every year a new opportunity to showcase DaVita’s rapidly expanding earnings per share to an audience of brokerage analysts and portfolio managers. In the fall of 2011 Berkshire Hathaway disclosed it had taken a stake in the company, eventually accumulating just under 38.6 million shares, or 20.2 percent of the company’s public float, perhaps the biggest endorsement a management team can receive.

Shareholders, as the chart below indicates, took a cue from Berkshire and began purchasing DaVita stock hand over fist in the autumn of 2011 at its post stock-split prices in the low $30 range.



Those meetings are a little less rosy now, however.

At the May meeting, an analyst asked Thiry how much revenue DaVita generates from dialysis patients whose private (more formally known as commercial) health care insurance premiums are paid by the American Kidney Fund’s Health Insurance Payment Program.

Thiry’s response may be studied by future generations of reporters and investors: “We’re not [and] have not and it would not be in your best interest for us to start providing all sorts of detail on that other chunk.”

The Southern Investigative Reporting Foundation, which is attracted to executive prevarication like a large health care corporation is to a dubious insurance billing gambit — and whose interests assuredly lie in exposing undisclosed risk — took Thiry’s non-answer as a challenge.

After all, a limelight-loving CEO suddenly getting cold feet when asked a basic question about revenue breakdown is a pretty clear “tell” that whatever the answer is, it can’t be too good.

The answer looks terrible for DaVita’s investors. The company’s finances, according to a Southern Investigative Reporting Foundation accounting analysis, appear to be massively levered to an opaque nonprofit, the American Kidney Fund, that may provide up to half of its operating profits. They should define HIPP as a “gravy train,” albeit one perhaps soon to be modified by the word “imperiled” as a combination of civil litigation and regulatory shift poses an existential threat to this cozy relationship.


The definition of HIPP is unusually subjective, depending largely on whether you provide or receive dialysis, or insure those who undergo it.

To the former, the AKF and dialysis clinics — especially the larger chains — it’s an elegant solution to an end-stage renal disease conundrum of longstanding: With the one-two punch of its steep financial costs and the physical exhaustion emerging from treatment, working is often not an option, and many patients exhaust savings or go deeply into debt to maintain their private health care insurance policies. As a function of that, AKF’s HIPP pays its recipients monthly insurance premiums for the duration of their dialysis treatment.

For the latter, mostly insurance companies offering health care to the public, HIPP is a financial headache of a scale eclipsed only by its sheer evil brilliance.

They argue that in the AKF, dialysis providers created a low-risk gambit that exploits a narrow Department of Health and Human Services provision allowing third parties — that is, themselves — to donate hundreds of millions of dollars tax-free to the AKF. The fund then enrolls patients (primarily from its largest donors) who receive the same quality of dialysis care at the same providers alongside Medicare patients. But because a small segment of patients have HIPP, the dialysis providers — two of whom control almost three-fourths of the market — can bill insurers many times the roughly $250 per treatment that Medicare will pay.

Using DaVita’s Securities and Exchange Commission filings, the AKF’s Internal Revenue Service annual Form 990 filings and a little extrapolation, the Southern Investigative Reporting Foundation estimates that at a minimum, AKF’s support helps generate between 40 percent and 45 percent of the Kidney Care unit’s estimated earnings before interest and taxes, or at least $339.4 million through June 30, after a one-time $526.8 million legal settlement with the Veterans Affairs Department is backed out of its results. For 2016, it was more than $728.5 million.

(DaVita has two units: Kidney Care, providing patient dialysis and related lab services, and DaVita Medical Group, which owns physician practices. The Kidney Care unit’s earnings, given DaVita Medical Group’s consistent losses, are thus the company’s profits.)

What makes the AKF’s role so astounding is that those handsome profits come from a base of about 9,000 dialysis patients, barely more than 4 percent of DaVita’s 194,600 patients.

Last October, in response to insurer outrage over skyrocketing dialysis reimbursement levels on commercial policies purchased from the Affordable Care Act’s Health Insurance Marketplace, DaVita announced that it would no longer support patient applications for AKF premium assistance on those policies.

SoSurces: DaVita and AKF public filings and Southern Investigative Reporting Foundation estimates
Sources: DaVita and AKF public filings and Southern Investigative Reporting Foundation estimates


Where DaVita’s own figures weren’t available, conservative assumptions were made, like pegging the growth rate of dialysis patients — historically 3.8 percent — at 1.9 percent through June 30. Given that over 78 percent of the AKF’s $309.8 million in donations last year came from either DaVita or Fresenius Medical Care, the German medical conglomerate that is its primary competitor in dialysis services, the Southern Investigative Reporting Foundation estimated that at least 40 percent of the AKF’s HIPP grants went to DaVita patients.

(Both DaVita and the AKF declined to answer the Southern Investigative Reporting Foundation’s on the number of HIPP recipients receiving dialysis in its clinics, but based on interviews with executives at rival dialysis providers the 40 percent figure was deemed “very conservative.”)

DaVita, in its 2016 Capital Markets presentation, disclosed that privately insured patients are between 110 percent and 115 percent of the Kidney Care unit’s earnings before interest and taxes. To obtain the value of the AKF’s premium support to the company’s profitability, the quotient of the AKF’s commercially insured patients and the company’s commercially insured patients was multiplied by 113 percent.

Seen narrowly, given Thiry’s ownership of more than 2.54 million shares, refusing to discuss the question of AKF’s value to DaVita certainly served his “best interests.” Similarly, as an 18-year veteran of these presentations, he is surely aware that portfolio managers, trained to value a company based on a multiple of its future earnings per share, rarely pay 17 times earnings for a company whose profit growth is slowing and where 40 percent of the operating profit is dependent upon a charity and its circular donor scheme.

Another way to read Thiry’s reticence is as a function of the fact that the AKF relationship is — in the parlance of value investors — DaVita’s sole moat, or a sustainable economic advantage separating it from competitors.

DaVita is an unusual addition to Berkshire Hathaway’s portfolio because its moat isn’t a function of managerial acumen, such as GEICO’s efficiencies (which drive its lower-costs), or the pricing power resulting from global recognition of the Coca-Cola brand. The AKF relationship is a loophole, in the purest sense of the word, made fully legal as the result of a 1997 Department of Health and Human Services advisory opinion permitting donations to the AKF from the major dialysis providers.

Ted Wechsler, an investment manager at Berkshire Hathaway overseeing about $10 billion, didn’t discuss the AKF relationship when he elaborated on his thinking about owning DaVita to CNBC in March 2014.

Ironically, one of Berkshire’s leading lights was blunt with his contempt when offering an assessment of a much higher-profile insurance premium payment gambit at Valeant Pharmaceuticals International during a May 2016 Fox Business News interview.

Charlie Munger, Berkshire’s 93-year-old vice chairman, who has long been a student of what he calls the psychology of human misjudgment, said, “The main thing that Valeant did that was unbelievably clever was to pay the consumers part of the deductible for the drugs they were selling. . . . They paid the consumer share of the deductible and tried to pretend that it was a charitable contribution, when really it was the functional equivalent of bribing the other fellow’s purchasing agent.”

It’s not clear if Munger thinks the AKF is “unbelievably clever” also since he didn’t respond to a request for comment at publication time, but the carve out enabling donations to the AKF did two very important things: It appeared to seal off the fund and the so-called large dialysis organizations — then, as now, primarily DaVita and Fresenius — from prospective kickback allegations. It also enabled both companies to reap the fruits of their multiyear roll-up of competitors.

In a nutshell, insurance companies are required to offer dialysis coverage under network adequacy standards. This is no small matter given that the U.S. government annually spends an estimated $34 billion on dialysis suggesting that commercial insurers — often about 12 percent of the dialysis pool — may spend up to another $5 billion.

The consolidation of dialysis providers and the proliferation of commercial health insurance payors means that in most markets, a patient with end-stage renal disease in need of dialysis might only have DaVita and Fresenius to choose from, affording the company an unusually strong negotiating position.

So how favorable were the deals? The 2017 Medicare base payment for one dialysis treatment is $231.55, although a $250 “blended rate” that takes into account the Medicare Advantage program is likely closer to actual payment levels. For 2016, brokerage analysts estimated that DaVita’s received $1,050 per treatment from commercially insured patients. Even with 88 percent of their patients on Medicare or Medicaid, blended revenue of $346.98 (per treatment) through June 30 led to a 27.4 percent EBITDA margin.

Remarks from Thiry in January at the J.P. Morgan health care conference in San Francisco shed light on how some of these commercial contracts came to be so lucrative.

In a word: outlier contracts.

Seemingly unaware the microphone was still running, at about the 23 minutes 20 seconds point Thiry said that a few commercial insurers this year became aware that their dialysis contracts were so far above market that they chose “to do dramatic things” and “crash and burn” rather than quietly renegotiate. Fortunately, he said, “we’ve had those kinds of contracts for 17 years” and that there “are still a few” of these sharply above market contracts in place.

Source: DaVita Inc. filings
Source: DaVita Inc. filings


Having a few outlier contracts in force adds up, and quickly: Assuming three dialysis treatments a week for one patient, that $8oo daily differential between commercial and government reimbursement becomes $9,600 in a month and over a year, $115,200.

DaVita’s business imperative thus becomes simplicity itself: obtain as many commercially insured patients as possible, a plan congruent with its insistence that at current Medicare rates they lose money on 88 percent of their patients.

Enter the AKF.

As gambits go, the AKF relationship is tactically a stroke of genius: the donations to the foundation are tax-free and given an estimated break-even threshold of $250 per dialysis treatment, DaVita’s ability to collect over $1,000 per session generates a heroic return on its capital.

The connection between the HIPP program remaining in effect exactly as it is and the happiness of DaVita shareholders is essentially the union of two sets — should HIPP be curtailed, or a hard cap of two or three times the Medicare rate be placed on commercial insurance payments, its investors could see earnings per share cut in half.

What’s remarkable about this daisy chain is that the AKF only has one condition to satisfy. In the 1997 opinion, the HHS stipulated that the AKF had to make the HIPP program available to qualified patients with end-stage renal disease, and as part of the evaluation process, were forbidden from using the level of support given the foundation by the patient’s dialysis provider as a criteria.

A growing chorus of voices, however, are alleging that the AKF has not lived up to this obligation.

A New York Times investigation last December described social workers at independent and smaller dialysis organizations as having difficulty in obtaining AKF grants for their dialysis patients. In several instances, according to the Times, social workers said that their patients weren’t eligible for HIPP because of their clinic’s inability to donate.

Additionally, a St. Louis Post-Dispatch story last October cited internal DaVita emails in which dialysis clinic-based social workers appear to have been prompted to steer dialysis patients to commercial insurance policies, away from Medicare and Medicaid.

The relationship between DaVita and the AKF prompted the U.S. Attorney for the District of Massachusetts to issue a subpoena to the company in January.

Dr. Teri Browne, a professor at the University of South Carolina’s College of Social Work, told the Southern Investigative Reporting Foundation that as a 10-year veteran of clinic-based nephrology social work for Fresenius and Gambro Healthcare (a company DaVita purchased in 2004), that DaVita patients were encouraged to leave government insurance for commercial plans solely to improve dialysis revenues. In her view, she felt that this was distorting the mission of the social workers to deliver the best information for the dialysis patient.

(Last September, in response to a Centers for Medicare & Medicaid Services request for Information from end-stage renal disease stakeholders on whether patients were being inappropriately steered to Marketplace plans, Browne filed this statement alleging that this practice was occurring on a regular basis, especially at large dialysis organizations.)

Referring to the current debate over whether DaVita is using donations to the AKF to boost its revenues, Dr. Browne said that as she interpreted it, “The 1997 [HHS] ruling was originally written to help people with the supplemental charges in Medicare and Medicaid plans.” She noted, “Based on what I from interviewing dialysis patients, and what my email listserv [of nephrology social workers] is discussing daily, steering patients away from Medicare is now a closely tracked part of their business.”

And “no one is saying that the AKF or its policies are all bad,” she said, “but [the fund] is [incentivized] to expand clinic-centered dialysis. The large dialysis organizations, who give the fund most of its money, are the obvious beneficiaries.”

Asked what the biggest concern she has with the state of dialysis today, Browne argued that dialysis patients switching to private plans from Medicare/Medicaid are often put at major financial risk should they get a transplant. (The AKF’s premium assistance doesn’t cover transplants.)

“Higher premiums and co-pays are the patient’s obligation if they get a transplant,” said Dr. Browne, who added “patients can harm their listing eligibility for transplants by switching.”

Both the AKF and DaVita have strongly denied, to the Southern Investigative Reporting Foundation and other press organizations, any linkage whatsoever between donations and HIPP enrollment. The AKF said it has taken a series of steps to clarify its policies rejecting any quid pro quo, and it submitted this statement to the CMS last September in defense of its practices.

DaVita’s Thiry, in a Sept. 17 question-and-answer session at a R.W. Baird conference, defended premium assistance as functioning exactly as intended, with everything “totally above board,” while acknowledging “[HIPP is] precipitating quite a political football.”

Thiry also used the R.W. Baird conference as an opportunity to defend the broader concept of switching to commercial insurance, describing the coverage offered dialysis patients as being “vastly superior” to Medicare/Medicaid. (There is no data to suggest that private payers have any better clinical outcomes with dialysis than those on Medicare or Medicaid.)

DialysisPPO, a Malvern, Pennsylvania, dialysis consultancy that offers insurance plan and third-party administrators guidance in reducing dialysis costs, published a November 2016 white paper that argued a line broadly supportive of dialysis provider practices:

“When you lose money on 75% of your volume, you have to make extraordinary profits on the remaining minority. On average, our clients are charged 2,100% of the Medicare allowable amount for the same services. The average monthly charges for each [end stage renal disease] patient is $67,000 across our client-base. It is not unusual for monthly dialysis charges to exceed $85,000.”

Sarah Summer, associate general counsel and director of state policy for Blue Shield of California, took the opposite tack in this interview, claiming that “inappropriate third party payments” via AKF HIPP grants were part of “fraud gaming abuse” imperiling the health of insurers in the ACA Marketplace. Her arguments were amplified in Blue Shield’s Request for Information filing last September. Elaborating on the massive costs the San Francisco-based insurer alleges are shifted upon them, its statement described dialysis providers as using the AKF for “payment arbitrage” to capture up to $170,000 in payments per patient.

Blue Shield of California also stated that the burden of HIPP costs make it nearly impossible to remain economically vital: “Assuming a one percent operating margin for Blue Shield, it takes 3,800 members enrolled for 12 months to make up for a single dialysis patient enrolled by the American Kidney Fund.”

Notwithstanding the very real complexity of treating kidney failure, the fact of the matter is that DaVita made over $1.8 billion last year and its filings show that it hasn’t seen a sub-25 percent operating margin in ages. Those profits, common sense would suggest, come from its ability to push prices ever northward. The New England Journal of Medicine’s Catalyst blog, in an article in June, referenced a 2012 study from a trio of healthcare economists who, in analyzing the effect of competition on the quality of dialysis care for the National Bureau of Economic Research, found that’s pretty much what’s going on.

According to these economists, “average spending for DaVita and Fresenius patients rose about 50% from 2005 to 2009, to about $120,000 annually. Spending for dialysis patients in Medicare rose about 20% during that time, but reached only about $60,000 a year.”

More importantly, statistically speaking it doesn’t seem to matter who pays for treatments since U.S.-based dialysis patients face odds that are measurably slimmer than their peers across the globe. According to the University of California San Francisco’s Schools of Pharmacy and Medicine’s Kidney Project, as many as 25 percent of U.S. dialysis patients die in the first year of treatment, and only 35 percent survive as long as five years. The figures are even more stark when compared to a five year mortality rate of three percent for transplant patients.


The commercial insurers are not sitting on their hands and have taken to the courts to begin the work of pressing their interests, which mostly center around filling in DaVita’s moat.

The first shots were fired in a lawsuit filed last July when UnitedHealthcare of Florida sued DaVita competitor American Renal Associates.

Given that UnitedHealthcare’s primary line of legal attack is to frame the relationship between American Renal Associates and the AKF’s HIPP as a dubious “pay to play scheme” designed only to drive dialysis provider profits and not improve lives, the possible implications for DaVita and its interests are clear.

UnitedHealthcare alleges that the AKF’s administration of HIPP left little to the imagination about how little the fund adhered to the intent of the 1997 Department of Health and Human Services ruling, pointing to its “HIPP Honor System” whereby in the event dialysis providers were unable to “make fair and equitable contributions [to the AKF], we respectfully request that your organization not refer patients to the HIPP program.”

Through last autumn, UnitedHealthcare alleges in an exhibit attached to a filing made in June, this policy allegedly connecting HIPP grants to dialysis provider contributions was posted on the AKFs website.

Aetna is taking a different approach to addressing its costs from the AKF’s HIPP grants, at least for now. In April, it sued DaVita in Pennsylvania’s Montgomery County Court of Common Pleas to enforce what it claims are provisions in its contract with the company that allow it to examine data related to AKF HIPP grants awarded to Aetna members.

DaVita, naturally, disagreed that the contract has that provision and claimed that Aetna hadn’t followed the proper dispute resolution procedures. On the second-quarter conference call in May, Javier Rodriguez, the DaVita executive who runs its Kidney Care unit, told analysts that Aetna’s request was denied.

This isn’t the full picture of where things stand between Aetna and DaVita, though.

A Montgomery County judge rejected the emergency component of Aetna’s request but the balance of its litigation was left to proceed, a state of affairs Rodriguez termed “working with Aetna.”


Spokeswomen for both the AKF and DaVita declined to make executives available for phone interviews but provided written replies to emailed questions. DaVita was provided with the model used to determine the connection between AKF HIPP grants and its profitability, as well as the clip of Thiry talking at the J.P. Morgan conference. While dismissive of the Southern Investigative Reporting Foundation’s questions as biased, a spokeswoman declined requests to elaborate on what, if anything, was incorrect.

Corrections: The original version of this story carried an incorrect number for DaVita’s U.S. patients. According to the company’s third-quarter 10-Q, it is 194,600 not 214,700. Additionally, a reference to a published report that provided an inaccurate estimate of the combined Fresenius and DaVita market share was deleted.  

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BofI Federal Bank: Annals of the Bank of Misery

If you put together all the chief executive officers from the financial services industry in one room and asked them, “Who looks back on the years 2007 to 2009 with fondness?” it’s a very safe bet that only one hand would be raised.

That hand would be on the arm of a man named Gregory Garrabrants.

Don’t feel badly if the name doesn’t ring a bell. The enterprise Garrabrants has run since October 2007, BofI Federal Bank — a bank in La Jolla, California — is about as unlikely an institution to have prospered in those years as can be imagined.

As banks, thrifts and mortgage-finance companies were busy collapsing or receiving multiple federal bailouts, especially in Southern California (the epicenter of the global financial crisis), BofI was just beginning an earnings streak that’s seen its bottom line grow at a compounded annual rate of 44 percent since Garrabrants was hired.

Those are not bad returns for a CEO to deliver, especially for someone like Garrabrants, considering his previous job: chief of business development for IndyMac Bancorp, the fourth-largest U.S. bank to ever be seized.

Also not bad: On Oct. 23, 2007, the day Garrabrants’ hiring was announced, BofI’s closing share price was $1.76 and for fiscal 2008 its net income was just less than $4.2 million. By 2010 it was $21.1 million, with its fiscal year concluding on June 30. Today its share price is almost $24, and for the first nine months of the year the bank has reported income of almost $102.2 million.

None of the CEOs at our imaginary gathering can point to results like the stock price performance below of BofI’s for the last nine years.

Prices reflect a November 2015 4-for-1 stock split. Source:
Prices reflect a November 2015 4-for-1 stock split. Source:


Though Garrabrants is only 45 years old, his many achievements as an executive would seem to position him at the center of important conversations about assuming a higher profile in his community or within the banking industry and eventually a spot on the short list for CEO roles at money-center banks.

But those conversations don’t appear to be occurring, for reasons that are becoming increasingly clear.

That’s because Garrabrants is this market cycle’s self-appointed crusader against short  sellers. Put bluntly, he really hates them.

He hates them so much that he spends both shareholder and personal capital discussing his prediction that BofI’s critics will be sent to prison (undoubtedly one with “tiny bars“) for allegedly coercing former employees to make false statements that could drive down his bank’s share price. According to Garrabrants, when evidence emerges from BofI’s lawsuit against former BofI internal auditor Charles Matthew Erhart — whose October 2015 whistleblower complaint prompted Garrabrants’ recent outburst — it will reveal a “coordinated effort” between the media, short sellers and employees like Erhart.

Just as evil as coerced employees in Garrabrants’ Dante-esque “rings of hell” formulation are short sellers posting under pseudonyms on the popular investor website Seeking Alpha. Though several different authors have written critically about BofI, two of them, “The Friendly Bear” and “Aurelius,” have proved nettlesome enough that the bank subpoenaed them as part of the Erhart litigation. (BofI’s quest to get a leg up on short sellers has led it to do some odd things, like try to hire a well-known short seller for tens of thousands of dollars to identify other short sellers.)

Such allegations recall former CEO Patrick Byrne’s 2005 claims that a patchwork of conspiratorial relationships had created a “Miscreant’s Ball.” While Byrne’s allegations received a great deal of (mostly unflattering) attention for and Byrne in the U.S., when his theory was serialized by his colleague, former reporter Mark Mitchell, it proved libelous in Canada.

The current political climate has only inspired Garrabrants’ lexicon: During BofI’s second-quarter analyst conference call in February, he accused short sellers of publishing “fake news” and being “trolls.” In April using a favorite phrase of’s Byrne, Garrabrants referred to “captured media.”

Here’s the thing, though: BofI is winning handily if its income statement is any barometer. Nor should it go unnoticed that the last Seeking Alpha article critical of BofI was more than six months ago.

But if some BofI short sellers aren’t publishing many posts anymore, they don’t appear to have been driven off by Garrabrants’ relentlessly confrontational approach either, judging by the gradually increasing amount of shares that have been sold short.

(Given the amount of personal wealth that many CEOs have tied up in their companies’ stock, and the pressure that institutional investors place on them for short-term gains, expecting CEOs to be indifferent to short sellers is silly. But other approaches exist for a CEO to manage the challenge of having the company’s business model or prospects publicly criticized: Reed Hastings, the high-profile CEO of Netflix, responded to a December 2010 short thesis from prominent hedge-fund manager Whitney Tilson in a courteous, relentlessly logical fashion that not only led to more attention for the company’s rebuttal than Tilson’s initial claim but also proved remarkably effective at restoring the stock’s value.)

Intrigued by BofI’s drama, the Southern Investigative Reporting Foundation spent more than a year investigating the bank and concluded that Garrabrants’ obsession with short sellers is entirely justified: Their skeptical articles on BofI have put the crux of his modern banking miracle at grave risk. From where he sits, anything he and his lawyers can do to distract investors from what’s in the company’s filings is money well spent.

What those filings suggest is that BofI’s business model is quite different from what its management publicly discusses.

Moreover, BofI’s ability to generate the revenue and profits that’s made shorting its shares so painful has less to do with its proclaimed ability to structure mortgages suitable for unconventional but creditworthy borrowers or its deft touch in managing risk than something much more pedestrian: its push into consumer specialty-finance lending.

This is a nice way to describe lending to people or businesses whose circumstances make them wholly undesirable as possible clients for even traditional subprime lenders.

But as a lot of the CEOs from that erstwhile gathering above would attest to, the first wounds from this type of lending show up on the income statement; the fatal ones are on the balance sheet.


To understand where BofI is going, let’s start with where it’s been.

Founded in 1999 as the Bank of the Internet (with an official name change to BofI in 2011), it is a completely online bank without branches. At the time of its 2005 initial public offering, the bank was profitable, generating a little more than $15.7 million in revenue, primarily via lending to multifamily home builders. Let’s call this the era of BofI 1.0.

Fast-forward two years: Given BofI’s modest exposure to single-family home lending, the bank was in good shape just as the global financial crisis spread in the autumn of 2007. The newly appointed Garrabrants quickly took advantage of the widespread price collapse of mortgage-backed securities, particularly in the so-called private label market (securities whose principal and interest payments weren’t guaranteed by either Freddie Mac or Fannie Mae) and scooped up hundreds of millions of dollars of these bonds at rock-bottom prices.

The timing for this trade couldn’t have been better.

As the Federal Reserve and the Department of Treasury pumped many hundreds of billions of dollars into banks and financial institutions, the prices of the bonds rebounded sharply, generating a remarkable windfall for BofI’s shareholders, with virtually no risk. What’s more, the Southern California real estate market stabilized and loan demand climbed. Call this the dawn of BofI 2.0.

As effective as the mortgage-backed securities purchases proved to be, these bonds have been maturing at a rapid clip over the past three years. This has prompted BofI’s management to redeploy capital into a market where risk-adjusted returns are now much lower, while shareholders expectations have never been higher.

The challenge is real enough for Garrabrants and his competitors: Providing construction loans for multifamily properties isn’t terribly lucrative and currently yields about 4.5 percent. Making mostly 30-year fixed-rate loans for single family homes and apartments is even less lucrative, generating around 3 percent to 3.5 percent returns for BofI’s established rivals.

So what will be BofI 3.0?

The answer is that there are two versions: BofI’s and what’s in its filings.

The bank wants investors to believe that its outsized profits are the result of the willingness of primarily wealthy borrowers (with esoteric financing needs) to pay a good deal more for purportedly fast, expert mortgage service on jumbo loans.

Moreover, because BofI, unlike most of its competitors, doesn’t break out the yields on its various loan offerings, investors have to take management’s word for it.

This is how its astounding loan yield (5.72 percent last quarter) becomes the functional equivalent of a grandmother’s apple pie recipe: It’s the best there is but she won’t tell you how she does it, so you’ll have to be content with her explanation of “it’s a pinch of this and a dash of that.”

To be fair, BofI hasn’t given investors much reason to be skeptical.

Consider BofI’s performance in a Bloomberg-generated ranking of banks in the Russell 1000 and 2000 indexes using three criteria: return on equity, return on assets and net interest margin. Out of 272 results, BofI had the second highest return on equity and the eighth best return on assets. And despite its being an internet bank and having to attract depositors by offering higher interest rates than its traditional brick-and-mortar rivals,  BofI had a net interest margin within the top 20 percent of the banks surveyed.

Incredibly, BofI can do this all with loss reserves of just less than $46 million, or 65 basis points, on $7.02 billion of loans. Using the same universe of banks in the Russell 1000 and 2000 indexes from above, BofI placed within the top 10 percent of banks with the lowest ratio of reserves to total loans.

But how a bank arrives at great results matters. And with almost 76 percent of BofI’s third-quarter lending income being derived from single- and multifamily real estate, its arriving at a 5.72 percent yield is no light task.

A more accurate picture of BofI 3.o starts with understanding that the Federal Reserve’s policy of gradually increasing short-term interest rates is not great news for the bank since loans for one and five years are about $3.7 billion of its $8.7 billion in balance sheet assets. While the bank has steadfastly refused to confirm to the Southern Investigative Reporting Foundation whether these loans are adjustable-rate mortgages, it’s a reasonable bet that they are.

Why should that matter to the fast-growing BofI’s investors? During a period of rising interest rates borrowers usually want to cap their interest-rate expense and tend to pick a fixed-rate, 15- or 30-year mortgage. With lending now constituting 90 percent of BofI’s revenue, the looming slowdown in adjustable-rate mortgage-origination fees doesn’t help.

An examination of BofI’s loan portfolio reveals that its growth is now coming from commercial and industrial loans, whose value has spurted 80.5 percent from 2016’s third quarter to March 31 of this year.

Getting to the bottom of what drove BofI’s commercial and industrial unit’s nearly $400 million loan growth is a different matter though. BofI, to put it mildly, doesn’t give much guidance to investors, but evidence suggests that the company has been aggressively carving out a niche, serving as a lender of choice for lenders of last resort. The banks that BofI has financed are nonbank consumer-finance operations like Quick Bridge Funding and BFS Capital; they lend — at rates often north of 50 percent — to small businesses and individual borrowers not able to qualify for loans elsewhere.

How the Southern Investigative Reporting Foundation zeroed in on subprime lending as BofI’s new growth engine went like this: In early 2016, a quick search of the electronic court record system PACER and state court records yielded nearly 50 results for BofI Federal Bank, many for personal or business bankruptcy cases, as well as claims of default.

Why would a relatively small bank outside San Diego be listed as a creditor in bankruptcy claims for a New Bedford, Massachusetts, garbage disposal company, a Dumont, Iowa, truck driver and a Farmers Branch, Texas, imported car showroom?

The loans weren’t small, either: New Bedford Waste and a sister company took out $1.95 million in loans, for example, and Texas Import Sales borrowed $600,000. So when these businesses collapsed, real money was lost. (Odder still was the fact that in most cases these BofI-backed loans were personally guaranteed, bearing none of the asset claims or capital structure seniority that other lenders had in their loans to these companies. In other words: the only real security behind these loans were the personal guarantee from heavily indebted or recently bankrupt borrowers.)

So despite most bankruptcy filings being about 60 pages of deadly boring, bare bones reading, after the Southern Investigative Reporting Foundation studied the initial 50 BofI-related cases, and having interviewed 18 of the individual filers, it appeared that BofI is a central cog in a growing lending business that few have known about, let alone understood.

What is this new lending business?

From the outside, it’s supposed to look like factoring of accounts receivable, a legitimate and longstanding method of using short-term secured loans to improve a company’s cash flow. (A factor purchases a business’ invoices or accounts receivable at a discount to their face value. The difference between what’s paid and what comes in is the factor’s profit.)

A legitimate receivables factoring transaction involves a factor carefully scrutinizing the quality of the receivables and the borrower’s cash flow cycles; the word “careful” is not reflective of how these BofI-backed “working capital loan” and “business funding” operate.

With the ability to fund loans in a week or less, these lenders can quickly structure a $10,000 cash advance in exchange for the purchase of $13,500 in future receipts. Crucially, the lenders require access to a borrower’s primary business checking account, using the automated clearing house system to draft weekly — and sometimes daily — withdrawals of a fixed amount of principal and interest. If the weekly withdrawal doesn’t go through, a series of steep fees and interest rate penalties are assessed.

Most borrowers with whom the Southern Investigative Reporting Foundation spoke to described the process of repaying this type of transaction as incredibly difficult, considering the typical 40 percent interest rate. And when penalty fees and the like are assessed, the rates can be 50 percent or more, forcing many borrowers to seek relief through bankruptcy.

It’s fair to ask hard questions about these borrowers and what decisions led to their inability to repay loans that they entered into willingly, despite the steep terms. An equally valid consideration is why BofI-backed companies willingly competed to lend these troubled borrowers large sums of money, despite many dozens of documented prior bankruptcies, collapsed businesses and mountains of prior debt.

One thing is clear: This kind of lending, however distasteful, is perfectly legal. More important, it’s very lucrative.

This is the world of BofI 3.0, the Bank of the Internet’s lightly disclosed transformation into the Bank of Misery.


BofI’s foray into this type of lending is centered on something often described as “rent a charter.” It’s exactly what it sounds like: making loans to a borrower for an institution that doesn’t have a federal banking charter. While this is an idea that has been around for several decades and is often frowned upon, it’s a completely legal win-win for all involved.

The consumer lender gains a way to charge astronomical interest rates since usury laws don’t apply to federally chartered banks, and BofI can charge origination and processing fees, perhaps even capture some interest, before transferring the loan to the likes of BFS Capital and Quick Bridge Funding within 24 or 48 hours. (There are dozens of these operations but documents suggest that BofI works most closely with these two.)

This would appear to be a nearly risk-free transaction for the bank that generates perhaps a few thousand dollars of revenue per loan; at the very least, it’s nothing that would upset a curious investor.

It’s not a surprise that BofI painted just that picture in one of the very rare occasions the bank even acknowledged operating in this marketplace. On the third-quarter’s conference call in April 2016, Garrabrants said the “credit quality in our C&I book remains pristine” and the loans are “contributed to a bankruptcy-remote, special-purpose entity owned by the nonbank financial services company.” (That last sentence is a mouthful but what he meant is that all these loans are now someone else’s problem, legally and financially.)

But there’s a hook, and as these things go it’s a damned big one. What BofI does is not at all like the easy, two-step process described above; it appears that in many instances BofI lends the money to BFS Capital and Quick Bridge so they can purchase BofI’s loans to a borrower at par value. Whatever BofI’s precise role in this marketplace is, and it appears to be a gnarly mash-up of secured borrowing as well as both lender and vendor finance, it’s not as passive a process as it’s made out to be.

Nor is the business line that BofI now calls “lender finance” as risk free as claimed.

One of the clearest illustrations of this is detailed in an adversary proceeding filed in March by a trustee in federal bankruptcy court against BofI, Quick Bridge and others in the Chapter 7 proceedings of Lam Cloud Management LLC. A Cranbury, New Jersey-based data center, Lam Cloud Management filed for bankruptcy in May 2015. (BofI did not file a response to the claim.)

The trustee alleged that BofI and Quick Bridge conspired in a “blatant and transparent attempt to evade [New Jersey] usury laws, [Quick Bridge] engaged in a ‘rent a charter scheme’ by retaining BofI, a federally chartered bank, to originate the [Quick Bridge] loan.” More broadly, the claim alleges that the repayment terms proved so onerous that much in the business plans that the loans were supposed to pay for had to be scrapped, and a vicious spiral developed, with the company taking out second and third loans to remain current on its prior loans.

The six-month term loan was for $132,000 and, per the trustee’s complaint, it carried an effective annual interest interest rate of 76 percent, including $9,135.26 in origination and processing fees. (Apart from fees, the loan’s interest rate was 31 percent for six months, or 62 percent annualized.)

Repayment was via an automated clearinghouse withdrawal of $1,372.38 for 126 consecutive business days. At the time of Lam Cloud’s bankruptcy filing, $51,658 in principal and interest payments were unpaid.

The trustee’s claim spared little in its assessment of the “introducing broker” Synergy Capital as having “deceptive and unethical tactics” that “fraudulently induced” the debtor to take out three loans. (The introducing broker matches the borrower and the lender for a commission and is not connected to BofI directly.)

Most non-bank consumer finance companies rely heavily on unaffiliated so-called independent sales organizations to provide a flow of prospective borrowers and, to be polite, their sales tactics are often very high-pressure. That’s because many independent sales organizations were founded by men who worked at 1990s boiler rooms. Synergy’s co-founder, Glen DeLuca, for example, has a résumé that’s heart attack inducing, including the fact that he lost his securities brokerage license in August 1998 for failing to pay restitution to clients on another matter.

Not having a license didn’t stop him from selling stocks for several more years; what did, however, was his 2001 indictment for manipulating stock prices while working at Euro-Atlantic Securities, a brokerage that federal prosecutors alleged had members of the Colombo family, then one of New York City’s leading organized crime outfits, as secret owners. (DeLuca was sentenced to four years of probation, fined $10,000 and ordered to do 200 hours of community service. He didn’t return several messages left for him.)

On May 19, the trustee filed a notice of settlement with the court; BofI and Quick Bridge agreed to pay $30,000 and drop any claim related to the loan.

For its part, BofI’s spokesman Stuart Pfeiffer disagreed mightily when asked if the Lam Cloud settlement could serve as a precedent for borrowers or trustees to potentially sue BofI in other bankruptcy cases. In a follow-up statement, the bank said that negotiating a settlement before a response was due saved a great deal of money in legal fees, while drawing attention to the language of the consent order, which said both BofI and Quick Bridge Funding “informally” denied “any liability” against the trustee’s allegations.


Time spent studying the ecosystem of these loans, the lenders who make them and the borrowers who affix their electronic signature is an immersion in the rich broth of contemporary American failure.

After the Southern Investigative Reporting Foundation interviewed the 18 people who had listed BofI-backed consumer lenders as major creditors in bankruptcy, a question that became impossible to avoid was “Didn’t anyone vet you before you borrowed money?”

The answer is it depends on whom you ask.

As noted above, Garrabrants assured investors in April 2016 that the bank’s credit team “carefully monitors the borrowing base and underlying collateral value of loans.”

The recent career of one Mehrasa “Tony” Khodaverdi, a businessman in the Houston suburb of The Woodlands and the owner of Verdi Enterprises, a clothing, shoes and handbag wholesaler, who borrowed $35,600 from BofI on Feb. 17, 2016, could lend validity to the theory that there are different interpretations of “collateral” and “credit review” in circulation.

On Feb. 24, 2016, BofI assigned the loan to BFS Capital. (In many filings BFS Capital is listed under its trade name, Small Business Term Loans.) Despite his having made payments for 11 months, Khodaverdi defaulted in January with $25,341 left on the loan, according to a claim the lender filed in Montgomery County court on March 30.

The loan was unsecured, which was an unusual approach for BofI to take, given the fact that Khodaverdi had filed for bankruptcy in 2008, listing more than $1,060,000 in debts against $70,325 in assets. Moreover, in June 2013 he had been arrested and charged with felony aggravated assault.

Whatever the merits of second chances and Khodaverdi’s new business (he had owned a pair of restaurants in the Hattiesburg, Mississippi, area when he filed for bankruptcy protection in 2008), it’s unclear how granting him a loan using only his personal guarantee was a good credit decision. (A call to Verdi Enterprises was not returned and BFS’ attorney in the matter, Mark Bagnall of Jameson & Dunagan in Dallas, declined to comment.)

Every lender expects some delinquencies and losses. According to, the national credit card charge-off rate last year was 3.17 percent of all balances, down from 9.40 percent in 2009. But Khodaverdi’s bankruptcy claim is no outlier.

Getting to the bottom of how many bad loans have a connection to BofI isn’t easy, especially with the bank’s use of registered agents to cloak its clients’ identity on some UCC filings, like Khodaverdi’s. But using a combination of Bloomberg Law’s database and PACER, the Southern Investigative Reporting Foundation found 562 claims of default or bankruptcy creditor listings for Quick Bridge Funding and 82 of the same for BFS Capital. (As of now, it’s unclear how many have a connection to BofI.)

To date, about 70 of these are connected to BofI but the figure is growing as filers and defendants confirm (through documents) the bank’s role as a loan facilitator through a warehouse facility or so-called rent-a-charter activity.

According to BofI, the Lender Finance business is akin to financial alchemy: a growing hill of troubled loans doesn’t ever touch BofI — not a single penny of loss — while simultaneously being a dynamic profit engine whose prospects are bright.

If all this were not baffling enough, things got kicked up a notch when the Southern Investigative Reporting Foundation came across a motion filed in California Superior Court that Momentum Business Capital, an independent sales organization, brought against Quick Bridge Funding as part of a broader contract dispute.

In the motion filed on June 5, one of the exhibits contained a declaration from Ben Gold, Quick Bridge Funding’s co-founder and president, who, when asked to describe his company’s business model, said his company “acts as an agent and underwriter for BofI Federal Bank.” This would appear to suggest BofI is his company’s sole source of loans.

Similarly, at the end of the document is a very brief excerpt from a deposition of Quick Bridge’s chief executive officer, David Gilbert, who said that BofI prohibits his company from selling loans to third parties.

“As far as I know within BofI, we’re allowed to work on the revenue side, not the asset,” said Gilbert, using industry jargon for the loans. “We cannot sell the asset.”

Additionally, Gilbert said Quick Bridge was allowed to participate in the “revenue side” of the loan’s ownership, presumably meaning the cash from its interest income. (This begs the question, If his company owns the loan, what would prevent Quick Bridge from full revenue participation? Or with which other company must Quick Bridge share the income?)

So while these are only snippets submitted by one side in a legal argument, the Gold and Gilbert interviews have profound effects for BofI, if either regulators or their auditors read these documents.

Let’s boil a brutally complex issue down to its essence: BofI has promised, at length, that its balance sheet shows none of the credit risk associated with these often troubled loans because they have been sold to a business partner.

Gilbert’s deposition throws a big wrench into this argument.

He did this when he disclosed that Quick Bridge is forbidden from selling (or pledging) the “asset,” despite having paid the full value of the loan. Nor does his company appear to have full profit participation. (Gilbert didn’t return several calls and an email seeking comment.)

What lies at the bottom of the Pandora’s box of accounting “what ifs” that Gilbert’s remarks opened up?

Gilbert’s testimony about restrictions on selling and profiting from the loans implies they shouldn’t be accounted for using what PriceWaterhouseCoopers calls “sale accounting,” meaning that in some measure, they would have to be accounted for on BofI’s balance sheet. Very few investors want a bank that has a balance sheet with millions of dollars worth of loans to Mehrasa Khodaverdi.

The Southern Investigative Reporting Foundation asked BofI about Gilbert’s testimony in the deposition and the possible risk to its business.

While BofI did not address the remarks, a spokeswoman strongly defended its approach to lender finance: “The accounting treatment on our balance sheet and income statement is consistent with all applicable accounting rules and regulations and thoroughly reviewed and vetted by BDO, our external auditor.”

(After publication, the bank sent a follow-up statement noting it couldn’t comment on the Gilbert deposition but that the borrower — Quick Bridge — is free to do what they wish, provided criteria like “the loan balance is paid in full” or “excess collateral is available.”)

That may be true, but the accounting rules, as laid out by the Financial Accounting Standards Board’s Accounting Standards Codification 860, don’t appear to support the argument that loans in a “bankruptcy remote, special purpose entity” are completely free of BofI’s influence.

Let’s put on the green eyeshades, briefly. Last August Ernst & Young publicly released a lengthy document, Transfers and Servicing of Assets, that while a soul-crushingly dull read, does have an enlightening section about a “decision tree” that can guide accountants when addressing such issues.

In the middle bubble, the hypothetical question that could be posed to the auditor goes to the heart of this matter: “Does each transferee have the right to pledge or exchange the assets it received, and no constraint on the transferee provides more than a trivial benefit to the transferor?”

Based on Gilbert’s responses, it appears the answer for BofI is “no.”


BofI investors should settle down and get comfortable with the BFSes and Quick Bridges of the world, since the bank is making a big commitment to what’s called “the lending marketplace,” a series of lending platforms that seek to connect pooled lenders and borrowers.

To that end, in April the bank extended a $400 million loan to Victory Park Capital, a private equity firm whose portfolio includes numerous investments across the subprime spectrum, including AvantCredit, Borro, Kabbage and FastTrak Legal Funding.

The Victory Park Capital loan appears to have been secured by holdings in several Victory Park funds, according to Uniform Commercial Code liens that BofI filed (see pages 55 and 56). Richard Levy, Victory Park’s general partner, didn’t respond to several emails seeking comment.

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BofI Federal Bank: Disclosing Little, Saying Less

BofI Federal Bank’s disclosure practices seem baffling at best if the standard it’s judged by is how well it informs investors about developments that could potentially change the risk profile of their capital.

In fairness to BofI, the key word here is “baffling” since the laws governing U.S. corporate disclosures have few bright lines and a great deal of murkiness.

As Steven Davidoff Solomon noted in a New York Times column, the Supreme Court upheld in 2011 a previous ruling that if “disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the ‘total mix’ of information made available,” a public company’s failure to reveal certain information is considered “material” and could potentially subject it to civil and criminal investigation.

Left unsaid is the fact that companies may have their own opinions on who’s a “reasonable investor” and what he or she might consider “significant.” Hint: Companies often find ways to claim news that would prompt probing phone calls from investors and reporters isn’t significant enough to merit disclosure.

So, for example, Valeant Pharmaceuticals International went out of its way to tout its January 2013 hiring for its executive management team a former Medco Health executive Laizer Kornwasser. Valeant listed him on the company’s proxy statement and gave him a wide-ranging mandate, including oversight of its new relationship with a company called Philidor Fulfillment Services. When Kornwasser left in July 2015, however, the company didn’t say a word.

Accountants have long used a rule of thumb that if not the law is widely accepted as a fair guideline for materiality: If a company misreports a metric by more than 5 percent, that’s material and should be disclosed.

These already muddy waters turn pitch black when it comes to a company’s obligation to disclose regulatory investigations, said Tom Sporkin, a former Securities and Exchange Commission supervisory official now in private practice at Buckley Sandler LLP.

“There’s no hard and fast rule about disclosing an SEC investigation,” he said, noting that companies often retain a separate attorney to advise their general counsel on what should be disclosed. “Where materiality comes into play is if the investigation is centered on a key [officer] like the chief executive or the prospective financial liability threatens its operations, but presumably the subject would consider that.”

Sporkin, whose father Stanley Sporkin was a former SEC chief, added that the SEC tends to avoid weighing in on this issue apart from when “the public interest is clearly served,” such as in the case of a breach of a credit card company’s sensitive consumer information databases.

So BofI has a great deal of latitude about what it can tell investors. Some of the issues the bank’s management seems to think investors needn’t be bothered with are at least two regulatory probes.

Multiple former BofI employees told the Southern Investigative Reporting Foundation that within the past six months they had spoken at length to the Department of the Treasury’s Office of the Inspector General about BofI’s loan document preparation and how information about some of this had been presented to regulators. (These individuals refused to speak on the record, citing ongoing contact with the Treasury Department’s inspector general office as well as fear of legal reprisal. They said they had not had any contact with short sellers or lawyers suing BofI.)

An investigation does not suggest that the Treasury’s inspector general’s staff — which often works with the Department of Justice — would conclude any wrongdoing occurred. As of publication, BofI had not responded to a request for comment.

In March the New York Post reported that the Office of the Comptroller of the Currency, BofI’s primary regulator, is investigating whether foreign nationals had the proper tax identification prior to obtaining loans from BofI. The bank’s chief legal officer, Eshel Bar-Adon, referred to the Post report as “silliness” and said the company’s CEO Gregory Garrabrants had previously addressed these allegations. The bank hasn’t been charged with any wrongdoing.

To John Gavin, who runs the Probes Reporter, a Plymouth, Minnesota–based research service that uses Freedom of Information Act requests to detect ongoing SEC investigations, the question of whether BofI is being investigated was settled on May 25. That day Gavin received a notice from the SEC’s Freedom of Information Act officer denying his request “for certain investigative records” involving BofI because “releasing the withheld information might reasonably be expected to interfere with ongoing enforcement proceedings.”

Ordinarily, Gavin said in an interview, he would have been content to leave it at that. But he saw, via another FOIA request, how BofI executives were using FOIA to learn the identities of other individuals seeking information on the bank.

On Aug. 30 Gavin posted an article on Seeking Alpha correcting assertions by BofI CEO Garrabrants and Brad Berning, an analyst with Minneapolis-based brokerage Craig-Hallum, that market chatter about a possible SEC investigation of the bank was groundless. A few months ago, on Feb. 28, Gavin released a report asserting his findings of an ongoing investigation.

(In July 25 Craig-Hallum’s Berning had published a report, citing his Freedom of Information Act work as the basis for dismissing claims of an SEC investigation. Two days later, however, Gavin pointed out that Berning had received a notice from the SEC’s FOIA officer identical to what Gavin had received on May 25. This didn’t prompt Berning to re-evaluate his thesis, though. In a Aug. 31 note, he listed a series of reasons for considering the SEC’s FOIA result a “false positive.” Berning didn’t reply to an email and voice mail seeking comment.)

To be sure, as both Gavin and Berning observed, most SEC enforcement probes are closed without any action being taken.

Asked about Gavin’s work, BofI’s outside public relations counsel, Sitrick & Co’s Stuart Pfeiffer replied, “Due to false allegations made in short seller hit pieces and pending litigation, agencies routinely ask questions to assure themselves that such allegations are without basis. However, there are no material investigations that would require public disclosure and BofI remains in good regulatory standing.”


BofI’s disclosures about the nuts and bolts of its operations aren’t much more substantial than its sharing of regulatory probes, although the hush is stranger because the bank appears to have excellent financial results.

Consider FICO scores, the ratings system of credit strength for borrowers that’s a standard feature in the discussion and analysis of every bank’s lending operations. If a bank has a sizable amount of loans with lower FICO scores on its balance sheet, smart investors need to closely watch reported delinquencies and loss reserves.

BofI has an unusual FICO disclosure policy. The borrower information available for its small but rapidly growing portfolio of automobile and recreational vehicle loans is a model of clarity, telling investors the average FICO score and how much has been set aside to cover possible losses. As of March 31, BofI had a little more than $131 million of these loans on its balance sheet.

On the other hand, BofI doesn’t break out borrowers’ FICO scores for its $3.8 billion worth of single-family home loans. What the bank does disclose, in a veritable river of impressive-sounding mortgage industry jargon, is only marginally helpful in assessing the risk these loans pose to its balance sheet.

Here is an excerpt of what Garrabrants said on a third-quarter conference call in April: “The details of our third-quarter 2017 originations are as follows; the average FICO for single-family agency eligible production was 753 with an average loan-to-value ratio of 66.5 percent. The average FICO of the single-family jumbo production was 708 with an average loan-to-value ratio of 61.6 percent.”

Make no mistake: The single-family home loans Garrabrants referenced carry fine FICO scores, but the vast majority of them were probably sold off to the giant mortgage guarantors, Fannie Mae and Freddie Mac, generating profit for BofI. It would not be surprising if some of the jumbo loans had been sold off to Freddie and Fannie or another banks. In other words, the FICO scores the bank tells investors about tell them the least about balance sheet risks.

Many of BofI’s direct competitors, EverBank and HomeStreet Bank, for instance, disclose the FICO scores of loans kept on their balance sheet. Even Wells Fargo, a vastly larger competitor that’s recently gotten in truly hot water for other things, spent a whole page of its annual report breaking out its borrowers’ FICO scores.

Tamara Taylor, a BofI spokeswoman from Sitrick & Co., said the bank doesn’t disclose FICO scores on its portfolio of retained loans because its officials “aren’t required to.” She said that BofI’s filings break out loan-to-value bands on its single-family loans.

One of the ironic consequences of BofI’s weak disclosure practices is that this has breathed life into its own worst enemy: a small group of anonymous short sellers who plague the bank on Seeking Alpha and on Twitter. If BofI had been more forthcoming, they wouldn’t have been as likely to spend prodigious amounts of time and money to surface what they argue is material information that the bank didn’t want released.

One of these short sellers, whose pseudonym is “Spotlight Research,” posted a December 2014 Seeking Alpha article claiming that the bank was relaxing its documentation standards in making loans to foreign nationals in red-hot markets like Miami and Southern California. As proof, the author posted a BofI account executive’s presentation to mortgage brokers touting the bank’s lending to foreigners as a specialty. (The “Spotlight” author argued that foreign borrowers, who often lack many forms of documentation that are standard for U.S. borrowers, posed an enhanced risk for money laundering violations.)

Garrabrants briefly alluded to this controversy in an August 2015 New York Times article, arguing the foreign lending business line was “nowhere near the majority” of the company’s loans.

A formal disclosure about these type of loans came only two and a half years later during an April conference call, when Garrabrants said that this program now amounted to “15 percent of its jumbo mortgage production.” BofI didn’t provide a dollar value for this business on the call and refused to answer the Southern Investigative Reporting Foundation’s questions about it.

In August 2015 another short seller “The Friendly Bear” posted an article claiming that BofI was doing business with at least one broker who was pitching loans to residents of U.S. Treasury-sanctioned nations like Ukraine and Russia; the author suggested he had reviewed several loans made to residents of these countries in state filings.

Garrabrants, in the 2015 Times article, said that no regulators had raised concerns despite multiple reviews of his bank’s operations. This past April, he told investors and analysts that the foreign loans were of excellent credit quality and that the bank hadn’t sustained any credit losses from them. BofI declined to answer more specific questions about this business.

The Southern Investigative Reporting Foundation located 40 mortgages from BofI to Russian and Ukrainian nationals for New York City and Miami properties. Another 36 Chinese nationals were identified as BofI borrowers, primarily for properties in Southern California.

One of the more interesting borrowers was Vadim Shulman, a Ukrainian national and alleged billionaire who took out a $12.5 million five-year adjustable rate loan in September 2014 from BofI at a 5.25 percent interest rate to purchase a stunning house in Malibu for $25 million.

For a man who’s that rich, the loan is an odd move, costing Shulman about $237, 324.80 a month, and the rate will rise to 8 percent in September 2019.

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BofI Federal Bank: Sleeping With the Enemy Can Cost a Bank a Lot of Money

In the evening of Aug. 8, 2016, a retired hedge fund manager named Marc Cohodes was puttering around the house on his Cotati, California, farmstead when he received a most unusual phone call.

The caller was Polly Towill, a partner with Los Angeles’ Sheppard Mullin and, according to Cohodes, she got right to the point: She was calling on behalf of her client, La Jolla, California-based BofI Federal Bank and she was authorized to explore retaining him as a consultant. What the bank needed him for, said Towill, was to help the bank’s legal team and its CEO, Greg Garrabrants, better understand how short sellers developed their opinions and how they shared their views.

Of particular interest to BofI, said Towill, was anything Cohodes knew about short sellers who published their research on Seeking Alpha, especially the one who used the pseudonym “Aurelius.”

Given who Cohodes is, a more improbable request is difficult to imagine.

A short seller for 30 years as a partner — and then general partner — of a prominent short-biased hedge fund, Cohodes undoubtedly knows most members of the small community of dedicated short sellers either professionally or socially.

(His approach to short selling is simplicity itself. Those few hardy souls who are willing to wager considerable sums against popular or beloved companies, regardless of market or economic conditions have what he describes as nothing less than “a genetic defect.” Most people are predisposed to be curious about how things work; Cohodes and his friends wonder how things break.)

Moreover, unlike most short sellers who keep a low profile for fear of attracting legal headaches and inducing costly short squeezes, Cohodes is unafraid to vocally defend the right of short sellers to publicly express critical opinions without being sued.

And these days now that he is free of the concerns of running a hedge fund, Cohodes is practicing what he preaches, big time. He regularly takes to Twitter — where he has a following of 14,400 — to riff on whatever enters his mind, such as delivering eggs from his free-range chicken flock to a San Francisco store, companies he’s shorted with his personal account, his fondness for the rock band Collective Soul and rum punch. On occasion he’ll put on a collared shirt and expand his Twitter schtick into a presentation, as he did when he appeared at the Grant’s Interest Rate Observer conference in April.

It’s best to not let Cohodes’ amiably profane informality mislead you, however. His commitment to short-selling companies that are, in his view, both mismanaged and operationally unsound is every bit as robust as it was when he was a hedge fund manager.

A glance at the one-year stock price chart of two of the companies he recently shorted, Canadian mortgage lenders Home Capital Group and Equitable Bank, suggests that he’s generating a nice return for himself, rum punch and free-range chickens aside.

So as Cohodes saw it, a call from a lawyer asking him to help BofI draw a figurative map to manage its response to a multiyear drumbeat of short-seller criticism, while possibly exposing other short sellers to litigation, was mighty damned strange.

Cohodes, whose public discussion of his short positions over the decades have made him intimately aware of the litigation process, told the Southern Investigative Reporting Foundation that he initially decided to respond “straight — no emotion, nothing.”

“I told [Towill] that since I’d never said or written a word about BofI, I’d be useless,” Cohodes said. Trying to be polite, he suggested only that Towill and Garrabrants need not worry about short sellers, he recalled.

“Buckle down, execute on your plan and try to be as open as possible. The stock [price] will take care of itself,” Cohodes remembered telling Towill. (In an email reply to Towill after the conversation ended, he reiterated this suggestion.)

Towill acknowledged this was “decent advice” but wouldn’t take Cohodes’ broader hint to drop the matter. He said she told him, “Greg is really upset with all the criticism being leveled at [BofI] and they needed advice on how to counter it.”

She asked if Cohodes would be willing to sign a contract and become a consultant. When he replied that he’d only done this once, charging $1,100 per hour, she wanted to know if that was still his going rate. Cohodes then tried being outrageous and countered, “$15,000 an hour, three-hour minimum, all expenses paid.”

Towill didn’t blink and asked, “Is that your final offer?”

Trying the direct approach, Cohodes plainly said there was no way he’d work for BofI.

Finally seeming to understand that he wasn’t going to consult for BofI, Towill floated  the possibility of using a subpoena.

“I told her this would be a terrible idea,” said Cohodes, who noted that she hasn’t subpoenaed him.

(Cohodes’ view about possibly receiving a subpoena? He is rich, has time on his hands and he “would never shut the fuck up about BofI,” potentially turning any legal proceeding into a three-ring social-media circus. As things stand, he has aggressively started criticizing the bank on Twitter.)

Towill did not return a phone call seeking comment.

BofI’s external public relations counsel, Sitrick & Company’s Stuart Pfeiffer, in response to questions from the Southern Investigative Reporting Foundation, provided a statement: “While we can confirm that Ms. Towill spoke to Mr. Cohodes, we are unable to discuss why the call was made or provide other answers that may constitute a waiver of privilege.”

Editor’s note: Marc Cohodes, through a charitable trust he controls and in conjunction with a conference appearance, in October 2017 made a $15,000 donation to the Southern Investigative Reporting Foundation. The interview with him for this particular article was conducted prior to his making the donation.

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Synchronoss Technologies: You Probably Wouldn’t Buy a Car From These Guys

The velocity of the destruction of Synchronoss Technologies investors’ capital is brutal to behold: In less than four months, the value of their investments has been halved.

There’s a reason for that.

On Dec. 6, Bridgewater, New Jersey-based Synchronoss announced an unusual pair of transactions that radically altered its business model just weeks before the end of its fiscal year: It paid twice the then price of shares to merge with the public company Intralinks and simultaneously sold the mobile-phone activation unit, which was responsible for almost half of annual sales for Synchronoss. This prompted the Southern Investigative Reporting Foundation to take a hard look at the company’s shift in strategy, whose sheer complexity masked some troubling details.

The Form 10-K annual report for 2016, filed on Feb. 27, probably won’t inspire investor confidence, though: Instead of providing reassurance about the radical transformation afoot, it reveals a series of accounting- and disclosure-related gambits that make for a very different company than the acquisitive, growth-driven one that’s been touted in press releases and conference calls.

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The cloud services unit of Synchronoss peddles data storage and analytics software to wireless providers who use it to offer customers branded cloud storage, such as Verizon Cloud. Apart from all the hype about “the cloud,” wireless companies view it as a customer retention tool, on the view that people who are already using one cloud service to store their photos, music or address books may be less likely to jump to a rival when a better deal comes along.

Synchronoss entered the cloud storage business by purchasing FusionOne in July 2010. Then just as the cloud storage market took off, Synchronoss began rolling up a hodgepodge of other companies involved with cloud-based software, including Newbay Software in December 2012 and F-Secure’s personal cloud business in February 2015.

With Synchronoss’ breakneck pace of acquisitions, its cloud services sales expanded at a torrid 72 percent annual clip from 2010 to 2016, making this unit, by its five-year mark, the biggest contributor to the company’s sales and income. In a stroke of good fortune, the unit’s growth accelerated just as revenue from Synchronoss’ original business line, mobile phone activation, started to taper off. To that end, cloud services made for a handy marketing point in Synchronoss’ presentations to brokerage analysts and money managers.

Throughout quarterly conference calls in 2016, former Chief Financial Officer Karen Rosenberger painted an increasingly rosy picture of the cloud services unit’s annual sales estimates: In May during the first-quarter call, she projected an annual revenue spike of about 27 percent, to as high as $390 million to $400 million. By the third-quarter call in November she forecast annual growth of 32 percent, anticipating sales of $408 million to $411 million.

So Synchronos investors, who in December had incurred $850 million of debt to purchase money-losing Intralinks, were probably completely shocked by the release of the 2016 10-K in February, with cloud services sales measuring just $389.9 million, below May’s initial guidance and well under November’s estimate.

To add insult to injury, the $74 million in increased sales–proudly trumpeted in the year-end conference call as proof of cloud services’ rapid expansion–merely amounts to corporate doublespeak; it’s an object lesson in how a company can meet all its financial reporting requirements yet still make investors bust their humps to find out what’s really going on.

Synchronoss is an aggressive acquirer of other companies and business lines, and with the sales from these purchased businesses folded into its own totals, showing growth is easy.

But at this moment in time investors would be wise to examine organic revenue — that is, sales derived from Synchronoss’ existing businesses but excluding revenue from acquisitions and other one-time accounting adjustments made the previous year.

In order to calculate this, disregard the $25.82 million in revenue reclassified from the mobile phone activation unit as cloud services revenue and instead consider it a one-time, noncash adjustment. Additionally, Synchronoss made a good-sized cloud services acquisition last March, paying $124.5 million for Openwave Messaging, so ignore the $42.5 million in revenue contributed from that. (Openwave’s roughly 10 months’ worth of revenue proved to be a boon for the company, amounting to almost nine percent of 2016’s total sales, despite CEO Stephen Waldis’ warning to analysts in May that its contribution would be minimal.)

Then there is a $9.2 million payment from Sequential Technology International Holdings for a “non-exclusive perpetual license agreement.” It’s fair to say that this entry is a rare bird for financial sleuths — something that looks initially odd and, upon further inspection, turns out to be even more problematic.

Sequential Technology International played a central role in the Southern Investigative Reporting Foundation’s Feb. 24 investigation after it purchased Synchronoss’ mobile phone activation unit on unusually favorable terms. Synchronoss failed to disclose numerous and long-standing connections between its CEO, Stephen Waldis, and Sequential Technology International’s parent company, Omniglobe International, a one-time related party that still does most of its business with Synchronoss.

While accounting standards afford auditors latitude in determining what can be recognized as revenue, permitting a $9.2 million noncash IOU from Sequential (a newly created company that already had an $83 million debt to Synchronoss) to count as revenue on Dec. 22, just days before the fiscal year’s end, is highly unusual. Moreover, the payment is not disclosed anywhere but the 10-K and not even mentioned in a separate Dec. 22 filing discussing the transaction’s terms.

(The license payment simply adds to the circus-like atmosphere surrounding the activation unit’s sale. In addition to having a $146 million bargain purchase price, the deal has involved precious little cash up front. It’s oddly a two-stage sale, as 70 percent of the unit was sold on Dec. 6 and the rest of the transaction is set to take place later this year. Sequential Technology International is also paying Synchronoss $32 million annually for three years in what it calls a transaction support agreement.)

What remains for Synochronoss after these items are subtracted is about $312.3 million in organic revenue for the cloud services unit, a mere $2.3 million increase over the prior year’s tally —  a sharp refutation of management’s assurances of continued growth. To the contrary, despite the company having spent hundreds of millions of dollars on building the cloud services unit over the past six years, it really isn’t growing at all.

 Source: Synchronoss' 2016 10-K
 Source: Synchronoss’ 2016 10-K


For its part, Synchronoss is sticking to its guns and arguing to investors, including at a presentation at a March 6 Raymond James conference, that its cloud services unit is expanding. In response to a question about the unit’s growth, Daniel Harlan Ives, senior vice president of finance and business development, suggested that calculations indicate the unit’s revenue to be $368 million, implying a 15.6 percent sales increase for the year.


The releasing of the 2016 10-K was hardly the first time Synchronoss’ investors have been force-fed some baffling disclosures about the cloud services unit’s economic health: Opaque transactions in the fourth quarter of 2015 as well as in the last moments of the third quarter of 2016 have made virtually no economic sense.

In the third quarter of 2016, Synchronoss announced earnings of 68 cents per share, at the higher end of analysts’ guidance of 65 cents to 69 cents per share. In a brief aside, CFO Karen Rosenberger referenced a $25 million licensing fee from Verizon Wireless that materialized in the last days of the third quarter.

What was the backstory for that $25 million fee? It was not immediately apparent during the third quarter earnings call with analysts, when Waldis cited a nondisclosure agreement as a reason for not providing much detail about the deal. Nor did it become evident in subsequent company filings. Even analysts at investment management firms that own Synchronoss shares have told the Southern Investigative Reporting Foundation they haven’t been given a clear answer.

Given Synchronoss’ managers are not shy about promoting its prospects, their silence on this transaction is telling.

The most obvious benefit of signing that $25 million contract was it allowed Synchronoss’ third quarter 2016 revenue and income levels to compare favorably with those of the second quarter of 2016 and the third quarter of 2015, metrics that are important to many brokerage analysts.

Perhaps the most striking thing about the Verizon Wireless contract from an accounting perspective, however, is the fact Synchronoss’ gross margins didn’t really change. Ordinarily a license payment boosts revenue with a minimal effect on the cost of goods sold. But in the third quarter of 2016 the gross margins declined in comparison with the same period in 2015.

Regardless, analysts and investors appear to have not considered that without Synchronoss’ signing a large contract in the last days of the third quarter, its results would have been abysmal.

Source: Synchronoss' third-quarter 2016 10-Q
Source: Synchronoss’ third-quarter 2016 10-Q


To investors concerned about earnings quality, the joint ventures that Synchronoss struck with Goldman Sachs and Verizon during 2015’s fourth quarter should also raise the alarm. As was true for the Verizon “licensing fee” above, details are scarce in the company’s filings and liberally coated with legal jargon.

One clue buried deep in the 2015 10-K is a footnote about “net income attributable to non-controlling interests” of $20.3 million from Synchronoss’ “new ventures with Verizon and Goldman Sachs.”

On the last day of 2015 Synchronoss signed a joint venture with Verizon, called Zentry LLC, that required Synchronoss to enter into a “non-exclusive perpetual license agreement” for $23 million. Synchronoss owns a 67 percent stake of the venture, which cost $48 million up front. (To be sure, this Verizon transaction is separate from the licensing fee deal in last year’s third quarter.)

Even less detail is provided about the Goldman Sachs venture, SNCR LLC; Synchronoss was required to take out a $20 million line of credit for it.

Whatever benefits the joint ventures had for Synchronoss in 2015 sure didn’t work out in 2016. According to the 2016 10-K, the “net income attributable to non-controlling interests” line is spilling red ink, amounting to a loss of slightly less than $11.6 million.

While there may well be more to Synchronoss’ joint venture story, from the little information that is available, the math is awful for shareholders: A little more than $20 million in profit in 2015 required the outlay of multiples of that amount. And the once touted joint ventures are now posting some sizable losses.

Every company strikes a bad deal now and then but this appears to be Synchronoss’ desperate financial engineering to generate short-term license fees.

There’s a noteworthy footnote to concerns over Synchronoss’ accounting and it has to do with executive stock sales: over the past two years, the company’s three most senior executives, ex-CEO Waldis, ex-CFO Rosenberger and President and Chief Operating Officer Robert Garcia have made a great deal of sales, either in terms of outright dollar value or the size of their holdings. (Both Waldis and Rosenberger left unexpectedly as part of the Intralinks merger; Waldis remains on the board of directors as its executive chairman.)

All three executives have made the sales as part of “10b5-1 plans,” a Securities and Exchange Commission rule designed to allow corporate insiders such as senior management or directors, with access to material non-public information, to sell or purchase a specified number of shares based on plans communicated to a broker several months prior.

Waldis, for example, since the beginning of last year, sold 329,769 shares for a little over $10.61 million; 2015 was also an active year for him, selling 202,713 shares for $8.94 million.

Rosenberger, whose trading activity had long been limited to modestly-sized size sales (often indicative of raising money for the tax liability related to options vesting), began aggressively selling on December 27, selling 24,023 shares for just over $940,000. With 32,846 shares left, as of April 1 she will have not to disclose her sales.

Garcia, like Rosenberger, had not been very active with respect to his Synchronoss stake but he also began selling with fervor at the end of last year, selling 66,055 shares since December 28, worth $2.38 million, through March 22. He has 77,000 shares remaining.


Daniel Harlan Ives, Synchronoss’ media- and investor-relations representative, declined to comment on questions submitted by the Southern Investigative Reporting Foundation.

He cited the company’s self-imposed quiet period in the weeks leading up to the quarter’s end. Spokesmen for Goldman Sachs and Verizon didn’t return calls seeking comment.

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Valeant: The End of the Michael Pearson Era

Valeant Pharmaceuticals International, the corporate poster child for price-gouging, tax-inversion and hedge-fund manager wealth destruction quietly severed all ties with J. Michael Pearson, its former chief executive officer and longtime guiding light, in January, according to its annual proxy statement filed this morning.

While Pearson stepped down from Valeant in May 2016, and struck a wide-ranging separation agreement that paid him $83,333 per month for consulting — especially the much-touted and at least temporarily disastrous Walgreens contract — his primary job was to cooperate with the seemingly eternally expanding roster of civil and criminal investigations.

The deal with Pearson was supposed to last through this December and the use of the word “initial” in the contract’s wording was a suggestion it might be renewed. Valeant, in the proxy, says it last paid him in October, and in December its board of directors determined no more payments would be made: “In December 2016, the Board determined that we are not in a position to make any further payments to Mr. Pearson, including in connection with his then-outstanding equity awards with respect to 3,053,014 shares.”

Pearson’s agreement was terminated in January for unspecified reasons.

Assuming that Valeant’s language is not implying that the company simply doesn’t have the cash available to pay Pearson, then a legitimate question becomes whether he did anything to violate the terms of his agreement through noncooperation. Given that it paid him $1 million annually with full benefits, allowing him to have an office, an assistant and legal fees paid for, this does not seem to be in his best interests.

Also of note is the timing of the cessation of payments to Pearson in October given that charges against Philidor Rx Services were filed on Nov. 17. While it is highly unlikely that Valeant’s board would have a sense of when — or even if — additional charges might be brought, their own counsel was assuredly aware that federal prosecutors have a long-standing practice of refusing to negotiate settlements with companies where they are actively pursuing indictments against current leadership.

(Southern Investigative Reporting Foundation readers will recall its investigative work from October 2015 that began an ongoing reexamination of the company’s ethics and business practices that has forced its share price to $10.86 in recent trading, down from over $257 in July 2015.)

A call to Scott Hirsch, Valeant’s communications chief, seeking comment was not returned.

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Synchronoss Technologies: The Friends and Family Plan

By any measure Tuesday, Dec. 6, was an extraordinary day for Synchronoss Technologies’ shareholders.

They woke up owning a stake in a company with a market capitalization above $2.2 billion and whose core software enabled consumers to activate, synchronize and store their mobile phone data.

By the day’s end, however, Bridgewater, New Jersey-based Synchronoss had purchased Intralinks Holdings, an unprofitable data-room developer, valuing it as if its stock were worth almost twice its then share price. Also Synchronoss said it had struck a deal to sell its legacy business, the mobile-phone activation unit, in two stages — 70 percent immediately and the 30 percent remainder over the course of the next year. Topping it off, Stephen Waldis, the company’s founder and chief executive, took the unusual move of stepping down to let Ronald Hovsepian, Intralinks’ CEO, run the newly combined venture, though he is remaining on the board of directors with the title of executive chairman.

Synchronoss marketed the effort as “accelerating strategic transformation“; investors just called their broker and sold, sending the stock price to $42.59 from $49 the day before, and erasing more than $290 million in market capitalization.

Waldis, on a Feb. 8 conference call with analysts, heralded the arrival of Synchronoss 3.0, an era that he sees as rich with cross-selling opportunities to businesses (as opposed to retail phone activation), more revenue diversification and a focus on higher-margin, faster-growing businesses like so-called white-label cloud storage.

In the main, investors haven’t warmed up to this vision, with the market cap dropping another $550 million to about $1.36 billion since the big day.

Investor confidence couldn’t have been bolstered when the merger’s proxy agreement disclosed Waldis had spent over half of 2016 seeking to depart his job, with Intralinks’ Hovsepian brushing off executive recruiters working for Synchronoss as far back as May. He became more receptive to Synchronoss when later overtures evolved toward buying Intralinks, which given his 2.21 million share stake, led to an almost $28 million windfall (as laid out on page 5 of the company’s 2015 proxy).

Concern over management’s vision for the business may prove to be the least of shareholder concerns as Synchronoss’ own documents reveal there is a great deal the public hasn’t been told about key aspects of its so-called strategic transformation.

For example, in 2006 the parent company of Sequential Technology International, the activation unit’s purchaser, was disclosed as a related party because Waldis and a group of his then-Synchronoss colleagues owned equity in it. Moreover, management’s comments about the reason for the sale, as well as the justification for the $146 million price tag, have been baffling.

Whatever the motivations behind the activation unit’s sale, Synchronoss’ own filings suggest that Waldis’ friends are in a position where it’s nearly impossible for them to lose money; the company’s public shareholders can say no such thing.


Synchronoss’ public statements about the activation unit’s buyer are incomplete, at best.

The Sequential Technology International portrayed in the company’s conference calls and press releases sounds like a standard corporate buyer, chosen after some consideration among a number of different options.

That is not even remotely the case.

To start, the Southern Investigative Reporting Foundation could not locate Sequential Technology International in any corporate registry or database. It’s a corporate shell, formed in early November  2016 whose website was registered by John Methfessel, a former neighbor of Stephen Waldis and an early-stage Synchronoss investor.

The first indication that there was more to the Sequential Technology International story than brief mentions in opaque press releases came from Stifel, Nicholas’ Tom Roderick: This research analyst published a Dec. 20 research note revealing that Sequential Technology International was a unit of Omniglobe International LLC. In his note, Roderick cited his own research, as well Synchronoss’ Dec. 7 filings, as being helpful to his analysis.

It’s unclear, however, what the Dec. 7 filings illuminated, since they don’t mention Omniglobe and only briefly reference Sequential Technology International as being “a new company.” The Southern Investigative Reporting Foundation tried to ask him but a Stifel spokeswoman said Roderick wouldn’t be made available for comment.

So what is Omniglobe International?

It’s a business process outsourcing company (often abbreviated to “BPO”) that handles nonessential tasks for Synchronoss’ activation unit. Through offices in the Philippines and India, Omniglobe provides phone activation customer service for Synchronoss’ AT&T contract.

In its June 2006 initial public offering prospectus, Synchronoss disclosed that Omniglobe was a related party, a legal term of art that in this case means that four of its officers had an investment in Omniglobe, and would benefit financially from doing business with it. (As detailed on page 74 of the prospectus, then-CEO Waldis had a 12.23 percent “indirect equity interest in Omniglobe,” former chief financial officer Lawrence Irving and former chief technology officer David Berry both had 2.58 percent and current president and chief operating officer Robert Garcia had 1.29 percent.)

These investments were made through Rumson Hitters LLC, a Delaware holding company that in turn owned a piece of Omniglobe. For awhile it was money well-spent: Between March 2004 and June 30, 2006, according to page 74 of the prospectus, Waldis’ investment yielded $153,655 in distributions from Omniglobe.

But the relationship must have raised a red flag somewhere since the prospectus — which doesn’t elaborate on the matter — does note that as of June 30, 2006, other, undisclosed members of Rumson Hitters had bought out the four executives, and that no one then at the company had a stake in the holding company or Omniglobe.

(“Rumson Hitters” is an inside joke among the families of several of Synchronoss’ initial founders like Waldis and his fellow Seton University alum Tom Miller. The phrase is used on Miller’s Facebook page, referencing the affluent New Jersey riverside town of Rumson where Miller lives.)

Daniel Ives, Synchronoss’ vice president of finance and development, told the Southern Investigative Reporting Foundation that Rumson Hitters was formed “to support the BPO business of Synchronoss” as it was getting started, prior to the IPO. He was emphatic that it has no ownership links to company management and should be viewed as “an unrelated third-party.”

He declined to name the owners of Rumson Hitters but speaking more generally about the sale to Sequential Technology International said, “I get it. This is a complex transaction and people have a lot of questions.”

There isn’t much publicly available discussing Omniglobe International but a December 2006 press release identified veteran telecom entrepreneur Jaswinder Matharu as its president and chairman.

Reached at his Potomac, Maryland, home, Matharu confirmed to the Southern Investigative Reporting Foundation that Omniglobe was Sequential Technology International’s owner and that it had purchased a 70 percent stake in Synchronoss’ activation unit. He said he expected to eventually complete the purchase for the balance of the unit “over the next year” with a loan from Goldman Sachs — Synchronoss’ longtime lead investment banker and co-arranger on the $900 million term loan used to purchase Intralinks.

When questioned about Omniglobe’s ownership structure, Matharu said he had a 50 percent stake and that “the Rumson Hitters hold the other 50 percent.” According to their registration filings, both Omniglobe and Rumson Hitters were registered in Delaware on the same day, March 5, 2004.

“I’m reluctant to speak about [the Rumson Hitters] part of the ownership group because they had to restructure things a little after the [Synchronoss] IPO,” said Matharu. Pressed on what “restructure” meant in that context, he said there were “legal moves” but that the Rumson Hitters entity was “still owned by friends and family” of Synchronoss. He declined to elaborate on who the “friends and family” were, nor would he identify the current partners.

Matharu said that a lawyer named John Methfessel controlled the Rumson Hitter investment and that questions about it should be directed to him. (In the December 2006 press release quoted above, Methfessel is identified as the owner of a legal transcription service that outsourced business to Omniglobe.)

A longtime specialist in defending insurance companies, John Methfessel would seem an unlikely candidate to be at the center of such a labyrinth corporate transaction but per above, he has numerous connections to Stephen Waldis, including having been his next-door neighbor for several years in Lebanon, New Jersey.

Methfessel was a pre-IPO investor in Synchronoss (both personally and through Moses Venture Partners L.P., a fund run out of his law firm’s offices) and is on the board of the Waldis Family Foundation, along with the aforementioned Tom Miller, a former Synchronoss executive who is now Sequential Technology International’s chief strategy officer. Both he and Miller are directors of Omniglobe International and a press release from last month referred to him as Sequential Technology International’s chairman.

Contacted at his office, Methfessel declined comment when asked about Sequential Technology International and the Rumson Hitter entity: “We’re a private company and I’m not going to answer any questions beyond what’s been announced.” (Miller did not respond to several phone calls and an email.)


Exactly what Synchronoss shareholders lost in the activation unit sale was made clear in a Dec. 22 filing where the unit’s pro forma financials — what it now calls “the BPO business” — were broken out.

Through Sept. 30, Synchronoss’ activation unit did $121.7 million in revenues and over $22.4 million in operating income, for an 18.4 percent operating margin and a 23.3 percent earnings before interest, taxes, depreciation and amortization (EBITDA) margin. While 2016 sales were flat, over the past decade they have grown at about a 15 percent annual clip and its biggest customer — AT&T is over three-fifths of unit revenues — has been with it since the company’s founding.

Going back in the company’s filings shows the same thing year after year: The activation unit is consistently profitable, bears little legal or regulatory risk, has manageable capital outlays and has a deep-pocketed primary customer with a need for the product.

Waldis didn’t see it that way, though. On conference calls in December and again in February, he dismissed the unit’s prospects out of hand and said it was “a lower growth business” and didn’t elaborate further. Ives, the Synchronoss vice president, said the unit’s growth and margin prospects “were sluggish” but did not expand on this.

To be sure, owning an asset that isn’t going to grow is a problem for any manager. The revenues stay constant yet costs and inflation usually increase over time. In this case, though, there’s a catch: On page 7 in the Dec. 22 filing Synchronoss disclosed that through Sept. 30 it had allocated over $24 million in “general corporate overhead expenses”  to the activation unit — costs that would “remain with [Synchronoss].”

In other words, the activation unit’s true profitability is a good deal higher than what was laid out in the company financials. Adding back those costs gives the activation unit a 36 percent operating profit margin, and it implies that Synchronoss sold it for 2.75 times EBITDA, an astonishingly attractive purchase price for Omniglobe.

Synchronoss’ Ives disagreed with the view that the unit was sold cheaply: “We had major BPO company’s give us lower bids than [what Omniglobe paid],” and he said that “it was a specialized but competitive process” that obtained those bids.

“The level of investment needed [for an effective BPO operation] is significant,” Ives cautioned. “That’s a competitive space and we saw margins coming under pressure.”

The Southern Investigative Reporting Foundation made the observation to Ives that it seemed nearly impossible for the deal to work out poorly for the buyers, to which he replied, “We hired an investment-bank to deliver a fairness opinion and they presented one to the board of directors.” Asked to disclose the name of the bank and produce the opinion, he declined, noting only that it was a “brand-name” bank. An educated guess would be Goldman Sachs, which advised Synchronoss on the Intralinks acquisition and is touted as a “strategic partner” in recent filings.

Not only did Sequential Technology International get a great price, but the Dec. 22 filing show it secured unusually attractive payment terms too.

To purchase 70 percent of the activation unit, Sequential Technology International only put down a little over $17.33 million in cash up front, along with $7.7 million in unspecified “contributed assets” and the $83 million balance in a note receivable. The 30 percent of the unit that Sequential Technology International hasn’t bought, representing $43.8 million in payment, is expected to be paid for sometime this year.

Sequential Technology International will also pay a licensing fee to Synchronoss for three years of $32 million — a figure that could increase if certain targets are met, said Ives.

“[The fee] isn’t [pure profit] for us since we’ve got ongoing expenses in software development and analytics offsetting those payments,” he acknowledged.

Per above, Omniglobe’s Matharu said that he expects to secure debt financing this year through Goldman Sachs to complete the purchase and a glance at the activation unit’s numbers suggests it shouldn’t be very difficult. If the unit’s revenue stays at about $150 million and a 30 percent operating margin (to be conservative) is attainable for a new owner, then the $50 million in operating income would easily cover interest expense.

These explanations do not address why the activation unit deal was structured in such a binary fashion. Instead of delivering the agreed-upon price in full as in a standard corporate asset sale, Omniglobe put down only $17.33 million in cash.

Synchronoss shareholders, who just took on $900 million in senior debt to purchase Intralinks, do not appear to be fairly compensated for fronting Omniglobe most of the activation unit’s significant operating profits and cash flows on what amounts to a layaway plan.

Ives defended the unusual sales arrangement as a function of the role of AT&T plays in the activation unit. “These are their customers we’re talking about and they said they wanted us to ensure a smooth transition, not just walk away,” Ives said.

Added Ives: “After the receivable is taken care of sometime in the next six months, we’ll have a lot more flexibility to get the best price for the 30 percent that remains.”

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Canadian National Railway: The Great Railroad Construction Robbery

Illustration: Edel Rodriguez

For much of the past two decades Canadian National Railway Co. has been credited with revolutionizing the North American railroad industry.

A theory of former company chief executive E. Hunter Harrison — of “precision railroading,” a data-driven focus on charging customers a premium for superior on-time performance — made him an industry icon and his shareholders very happy.

But in railroading, as in life, how one gets there matters.

Acting on a tip, the Southern Investigative Reporting Foundation began investigating Canadian National in the fall of 2014. Here’s what its reporting uncovered:

  • For over 15 years Canadian National earned hundreds of millions of dollars in profit by marking up rail construction costs up more than 900 percent to a public-sector client.
  • Canadian National regularly engaged in questionable business practices like charging internal capital maintenance and expansion projects to the same taxpayer-funded client and billing millions of dollars for work that was never done.
  • A just-released auditor general investigation suggested a series of reforms designed to reduce these profits.
  • For years, train yard personnel, under intense pressure from management, have intentionally misreported on-time performance, helping the company boost revenue by hundreds of millions of dollars.


On the evening of Dec. 6, 2004, two longtime Canadian National railroad employees, track construction supervisor Scott Holmes and his boss, railroad construction chief engineer Daryl Barnett, were in an elevator at the Deerhurst Resort a few hours by car north of Toronto and on their way to their unit’s Christmas party when Barnett got a call from Manny Loureiro, his supervisor and then head of engineering for the eastern region.

Taking the call on speakerphone, Loureiro told Barnett that he was in a bind because the fiscal year was drawing to a close and his division’s budget was $12 million over what his then boss, Keith Creel, the eastern region director, had set. Missing his budget bogey would be a major blot on his performance review; it would also eliminate his eligibility for a six-figure year-end bonus. (Editor’s note: All dollar values expressed are Canadian dollars.)

To avoid this, Loureiro told Barnett to transfer $12 million to his unit’s account from a $28 million advance payment that a customer had recently made to purchase signal equipment.

Barnett tried to object but was overruled.

After the weekend when they were back at the office, Barnett told Holmes that Loureiro had requested a transfer of $2 million in addition to the $12 million.

A week later during a conference call that included most of Canadian National’s senior management, CEO Hunter Harrison singled out Loureiro for commendation, singing his praises for having obtained such a large payment from a key customer so late in the year.

Barnett and Holmes concluded that Loureiro must have met the requirements for the maximum bonus.

The customer was GO Transit, Metro Toronto’s commuter rail system, which merged five years later with Metrolinx, Ontario’s taxpayer-funded public transportation agency. The required signal equipment was installed but the $14 million was not returned to Metrolinx’s construction project’s account, according to a former unit executive.

(Loureiro has retired from Canadian National and did not respond to a message left at his residence. Barnett, who left Canadian National in 2008, is now Metrolinx’s director of railway corridor infrastructure. He did not reply to an email and a phone call requesting comment.)

On Nov. 30 of this year when the office of Ontario’s auditor general publicly released its 2016 annual report, a 38-page chapter detailed Metrolinx’s billing and rail-construction project-management practices over the previous five years. The auditor general’s staff concluded that both of Canada’s major railroads, Canadian National and Canadian Pacific, profited from Metrolinx’s lack of internal financial controls by marking up construction charges well above industry norms.

A reader doesn’t have to parse the report too closely, however, to see that the auditor general took a keen interest in Canadian National’s work for Metrolinx. Put bluntly, the auditor general laid out a case that Canadian National saw Metrolinx coming a mile away and sought to harvest every last taxpayer dollar.

The auditor general’s investigation concluded that Canadian National had billed Metrolinx for new rail products but installed recycled ones from other tracks, that Canadian National’s labor prices were 130 percent above the industry average and that Metrolinx had been charged for projects that had nothing to do with commuter rail lines.

The money involved is real enough: The report stated that Metrolinx paid Canadian National and Canadian Pacific $725 million over the past five years and Canadian National’s projects were singled out as examples of bad news for Ontario’s taxpayers. On one project Metrolinx was charged an astounding $95 million for nine miles of track constructed on the Lakeshore West line.

Christine Pedias, a spokeswoman for the auditor general’s office, declined to specify how much each railroad was paid. It’s fair to assume, though, that the majority of Metrolinx’s construction payments went to Canadian National since most of Toronto’s commuter trains run on railroad tracks it owns or sold to Metrolinx.

Anne Marie Aikins, a Metrolinx spokeswoman, provided via email a statement from the agency’s president, Bruce McCuaig, “The Auditor’s report focuses on a small sample out of the many hundreds of projects Metrolinx is currently working on or has completed between 2011 and 2016.” Additionally, Metrolinx is “proud of its record” and taking steps to address the issues raised.

For its part, Canadian National spokesman Patrick Waldron reiterated to the Southern Investigative Reporting Foundation the statement it made to news organizations on Nov. 30 about the auditor general’s report, “CN is dedicated to transparency, fairness and accountability in all its contracts and projects with Metrolinx and Go Transit. Projects we have partnered on utilize rigorous construction management processes covering project specifications and budgets to deliver quality work with strict oversight.”

The auditor general also made a series of reform recommendations for Metrolinx that, if implemented, would save Ontario taxpayers money and thus hit Canadian National squarely in the wallet. These included carefully assessing labor and equipment estimates for “reasonableness” using industry standards as a benchmark prior to a contract’s approval, regularly auditing a project underway and assigning an inspector to monitor progress at construction sites.


Long before the Ontario auditor general’s office began its investigation, Canadian National was using Metrolinx as an automated teller machine, albeit one with no deposits required. Over 15 years executive teams have come and gone at Canadian National but the one constant has been the river of profit that its Toronto construction unit has been able to reliably wring from Metrolinx.

Determining how much Canadian National billed Metrolinx over the past two decades is difficult but considering since 2010 four separate land sales, Lakeshore West construction and ongoing maintenance contracts, it’s at least $1.1 billion, the majority of which likely went to operating income. In other words, Metrolinx’s long-running failure to properly scrutinize Canadian National emboldened it to charge prices so high that many of the construction and maintenance contracts amounted to almost pure profit.

The most audacious episode occurred from 2004 to 2008 when Canadian National’s construction managers developed a billing scheme that reaped hundreds of millions of dollars in profits and benefits through wildly inflating the cost of construction, according to documents obtained by the Southern Investigative Reporting Foundation and attached to ongoing litigation.

The project involved a track expansion project that Canadian National performed for Metrolinx’s Lakeshore West line, on a route that stretched about 40 miles from Hamilton, Ontario, to Toronto’s Union Station. The work was completed in 2012.

Windfall profits and bonus payouts weren’t the half of it. In numerous instances Canadian National billed Metrolinx for work that Canadian National did for its own capital maintenance and expansion projects, saving itself many millions of dollars in expenses.

From 2004 to 2008, Canadian National did track construction work for Metrolinx on a 4.5-mile stretch between the Burlington and Hamilton stations, referred to by Canadian National as Lakeshore West/West. On a separate stretch of the same track in late 2009, crews began adding track to the 9.1-mile stretch from the Port Credit station to Kerr Street, or the Lakeshore West/East line. (The Ontario auditor general’s annual report discussed an unnamed 9-mile track extension that cost $95 million to construct “on the Lakeshore West corridor” but did not identify the project’s location or its date of completion.)

The Lakeshore West/West project’s cost is unclear.

According to an email, Metrolinx had originally approved a construction price tag of $45 million, but in short order the project’s chief engineer, Daryl Barnett, in a bid to reduce costs, noted that the price tag had quickly ballooned past $70 million. Metrolinx’s spokeswoman Aikins did not answer repeated questions on the matter but the Southern Investigative Reporting Foundation obtained an April 2015 internal audit Metrolinx conducted at the auditor general’s request that put the final tab for Canadian National’s 2004 to 2008 work on that stretch at “over $200 million.”

What cost “over $200 million?” Three Canadian National railway construction unit staffers (including current and former employees) said the only project underway on Lakeshore West at that time was the Lakeshore West/West and that commuter trains were fully operational on that stretch by the spring of 2006.

(The audit document itself is highly unusual: Metrolinx’s internal auditors asked Canadian National to reauthorize their expired “audit rights” in order to properly document the project’s cost in terms of the labor and material provided. But the railroad refused, forcing the auditors to analyze the billing using only Metrolinx’s documents. The report concluded that the Lakeshore West project had no payment irregularities.)

Interviews with former Canadian National construction employees suggest that much of the Lakeshore West cost run-up can be attributed to Canadian National’s billing Metrolinx for an extensive series of upgrades around Canadian National’s Aldershot train yard. This was work of little apparent benefit to a commuter rail service like Metrolinx. From 2006 to 2007, Canadian National added a mile of mainline quality track enabling newly assembled freight trains to be switched onto another track when exiting the yard so they could rapidly increase speed.

How did they do this? The crew built switches or “turnouts,” which are mechanical installations that guide a train from one track onto another.

Improving access to and from the Aldershot yard solved twin logistical headaches for Canadian National that were its greatest challenges in the Toronto region. Previously trains exiting the Aldershot yard traveled 15 miles per hour and had to switch onto the main tracks at that speed, thus slowing the trains behind them. Now they can reach 25 mph. After improvements at Bayview Junction, Canadian National trains can reach 40 mph when traversing through those switches, sharply lessening the frequency of backlog-inducing stalls during a trip up Dundas Mountain.

Those improvements, according to former construction unit executives, appear to have been charged to Metrolinx.

The picture, below, taken from the Snake Road overpass in Burlington, Ontario, shows a few of the switches that were in the area around Canadian National’s Snake Road facility when a reporter visited the bridge in October. About nine were apparent. This is sharply more than a mere commuter train could ever plausibly need but helpful to long freight trains arriving from Toronto (such as those of Canadian National). Documents suggest that costs mounted rapidly for Metrolinx at least partly because of Canadian National’s order for at least 25 switches: The cost to install them was about $1 million apiece.


Canadian National’s documents indicate that building track is a remarkably profitable business and that doing so for Metrolinx has generated the type of margins usually enjoyed by  the developers of a breakthrough medicine.

According to a March 2006 Canadian National internal pricing spreadsheet obtained by the Southern Investigative Reporting Foundation, Canadian National could build a mile of track for a little over $1.12 million: This included a “track labor surcharge” of 138.4 percent and a 69.1 percent “track material surcharge.” (These surcharges, according to the Ontario auditor general’s report, were sharply above industry norms.)

But by charging Metrolinx $10 million to construct a mile of track, Canadian National was able to reap a profit of almost 900 percent.

(Not every customer was charged this way, however. In 2008 Canadian National built track for the federally owned Via Rail for $3 million a mile — without any bridges or switches — in Kingston, 150 miles away from Toronto.)

Nonetheless, Metrolinx had clear oversight provisions to safeguard taxpayers that were built into its Lakeshore West contracts with Canadian National, including a requirement for audit committees, frequent inspections and even aerial photographs, according to copies of the contracts obtained by the Southern Investigative Reporting Foundation. The problem is that all these measures stayed on paper and none appear to have been followed, according to interviews with former employees.

To profit from Metrolinx work, Canadian National used accounting practices that would ordinarily never have publicly surfaced. Unfortunately for Canadian National, though, former construction manager Scott Holmes, who has been fighting his termination from his construction supervisor job since 2009, has claimed that he was let go, in part, because he observed — and complained about — improper billing practices.

In late October of this year Holmes’ legal team submitted a pair of exhibit-heavy filings in response to a sworn affidavit from Gary Poplyansky, a former Canadian National finance official. (Holmes declined to expand on his filings, given the ongoing litigation.)

One of the more profitable accounting gambits that Holmes has claimed to have observed is best described as “over budgeting.” Having agreed in advance to pay annual maintenance and service charges, Metrolinx paid for scheduled work that Canadian National charged it but never performed. A November 2005 email from Canadian National’s Edmonton, Alberta-based capital-projects finance officer, Joe Vanderhelm, to James Lam, then finance chief for the railroad construction group, asked if a total of $3.66 million in capital improvement and labor costs already budgeted for would be incurred by the end of the year. They were not, according to a former construction unit official.

Metrolinx officials apparently did not suspect anything was amiss and the $3.66 million was paid. At Canadian National these funds became a “betterment,” a catchphrase for revenue in excess of the managers’ year-end objectives and often the basis for a performance bonus.

Time after time, with a few keystrokes, Canadian National’s railway construction managers made almost any financial concern vanish by assigning the costs to Metrolinx and its seemingly endless pool of construction cash.

In a December 2004 email, construction unit engineering chief Barnett outlined how $207,000 in costs could be billed to Metrolinx and thus make a $385,000 over-expenditure drop to $78,000. Additionally, Barnett ordered Holmes to get “7000 PW 14-inch tie plates.” In railroad construction parlance, PW means “partly worn.” In other words, a key element used for the construction of new tracks, the tie plates, had already been exposed to heavy use and weather.

Another internal accounting maneuver saved Canadian National millions of dollars in track maintenance and construction costs through the manipulation of the letter code system the railroad’s computers used to assign bills to Metrolinx.

Here’s how it worked: Rail crews completing work on Canadian National’s assets would submit invoices that were assigned a payer code that began with the letter C. Shortly afterward, a construction unit office worker removed the invoice from the system and changed the payer code, using a pen to write an M, which typically meant that Metrolinx would be assigned the bill. (Payer codes that began with an M, as Holmes noted in his affidavit, were used to designate third-party payers, which often — but not exclusively meant Metrolinx.)

Copies of several hundred changed invoices that the Southern Investigative Reporting Foundation obtained during a series of in-person interviews conducted in Canada suggest that the gambit was frequent and brazen, with Metrolinx assigned bills for work performed in Niagara, a locale far beyond the reach of its commuter trains (as shown in 11 documents.)


Over the past 15 years, Canadian National’s reputation for efficiency has been quite a calling card for the railroad.

Practically speaking, improvements in efficiency metrics are highly attractive variables for investors who want to see that a railroad is using its assets to the fullest extent possible, while railroad operations managers want to meet performance targets and qualify for bonuses. Canadian National tracks these metrics on its website.

“No one on Wall Street has ever gotten fired for owning the most efficient company in a sector and in railroads, that’s [Canadian National],” said rail industry consultant Larry Gross.

“Being the on-time leader, having the least dwell time in rail yards, those are major factors that allowed [Canadian National] to get and keep price hikes that constantly outpace inflation,” Gross said. In turn, he added, Canadian National’s price increases have kept profits — and thus its stock price — healthy, despite slowdowns in other areas of the economy.

Charts available from, a website that collects voluntarily disclosed efficiency metrics from six North American long-haul railroads, documented Canadian National’s dwell time — the amount of time a railcar spends in a yard or terminal before it’s sent out again — and suggest that this company is literally set apart from the competition.

But there’s more to the story than Canadian National’s hard-won gains in asset utilization and it involves “ghost tracks.” This is a railroad term used to refer to the practice of assigning a delayed train a made-up track number in a train yard. That way the incident can bypass a railroad’s daily inventory management system so that the lag doesn’t drag down efficiency metrics.

A 2013 whistleblower lawsuit filed against Canadian National in U.S. District Court in Memphis, Tennessee, surfaced the practice of making a train disappear in a computer system. Timothy J. Wallender, the suit’s plaintiff, was a trainmaster for Canadian National in Memphis who claimed that he was fired in retaliation for alerting his superiors to widespread misreporting of train metrics, much of them at the behest of his boss, then the yard’s general superintendent.

Canadian National argued that Wallender was fired solely for ignoring a warning about misreporting data, and when the company discovered in late 2011 that this had occurred, its president, Keith Creel, released a letter to employees demanding it stop. In February a U.S. magistrate judge granted Canadian National’s motion for summary judgment, ruling that the company was within its rights to fire him.

What the Wallender case shows is that circumventing the Canadian National computer system to arrive at ever-improving on-time and train dwell statistics was a fairly widespread practice, with a variety of different tactics used — from rail scanner manipulation to changing the internal clock in the railroad’s office computers — at yards throughout U.S. and Canada.

Paul Bourzikas, a former trainmaster colleague of Wallender in Memphis, said in a March 2014 deposition that the Memphis train yard was hardly the only Canadian National one where employees changed departure and arrival data.

“It happens all across that system,” Bourzikas said. “It happens in Geismar. It happens in Baton Rouge. It would happen in and out of Jackson. It would happen in Chicago.”

An October 2013 Canadian Broadcast Corporation investigation based on Wallender’s suit quoted two of his former colleagues in Memphis who corroborated his assertions about the extent of manipulated efficiency data. (A followup CBC report interviewed a British Columbia-based former Canadian National train conductor who alleged that he and his colleagues regularly went to great lengths to misreport trains as having departed when in fact they were tied up in the yard.)

The Southern Investigative Reporting Foundation interviewed six current and former Canadian National employees, all unconnected to Wallender’s litigation and having 15 years or more of train yard operations or transportation unit experience, about whether efficiency data like dwell times or terminal arrival data was often misreported. They declined to speak on the record for fear of losing their jobs or being sued for publicly discussing company-specific issues.

The consensus view of the six was that the practice of misreporting such data was endemic throughout Canada National’s operations in the U.S. and Canada until 2014, when this began to occur less frequently but still occurs.

Additionally, all six argued that investors’ and analysts’ ignorance of just how many things go awry when a train is hauling nearly 10,000 feet of freight to a terminal made them susceptible to believing management assertions about sharp drops in dwell time.

“It is virtually impossible for any long-haul [freight train] to arrive on time,” said a former Canadian National employee, a 25-year veteran of train yard operations. “No one wants to hear it, then or now. So when [Hunter] Harrison came in and on-time delivery became the focus, yard [superintendents] had massive pressure put on them,” he said.

The biggest component of delays, according to the six, were “slow orders,” or directives from, say, Transport Canada’s rail safety inspectors, to decrease speed on a specified stretch of track, usually because it needed repair.

One train engineer with more than 30 years of experience said, “What do you [suppose] happens to your on-time guarantee when you have six slow orders on a 800-mile run with 150 cars behind you?” He went on to describe decreasing speed many miles before the actual slow order and then waiting until the train cleared the area, only to have to do it again and again.

Nor are they the speedy shipment’s sole foe. “Your time and speed [measurements] get [screwed up] when you ‘pop a knuckle'” he said, referring to when a  coupling device connecting railcars to one other snaps. “You have to stop the train and walk hundreds of yards to find where it is, repair it or even call a crew and then get going again. Happens all the time.”

(Slow orders or relatively minor mishaps like “popped knuckles” can and do happen to all railroad companies, not just Canadian National.)

Another yard operations veteran, with 20 years of experience, said that he first learned of ghost tracks about 15 years ago at Canadian National’s MacMillan yard in Toronto when a manager finally got fed up with his supervisors’ castigating him for the yard’s dwell-time figures.

“He came over to my desk and walked me through how to do it,” he said. “So we immediately improved on our arrival/departure and dwell time numbers. No one asked us how we [had] done it,” he added. Nor did the manipulation involve just so-called ghost tracks but, per the accounts described in the Wallender claim and news reports above, it included moving trains a few hundred yards to trigger the scanner, making Canadian National’s computers to mark the train as departed.

In response to a reporter’s question about the possible risk of being deceitful, the yard manager laughed scornfully, “In the railroading [life] the shit runs downhill. No one who lasts long in the job asks many questions [of] a man who’ll fire you.”

A 34-year veteran engineer said he witnessed firsthand while driving trains to Sarnia, where Ontario borders Michigan, how effective ghost tracks could be in keeping a train away from prying eyes.

“After taking a shipment down there, they had [internal yard] printouts we’d see where the train’s destination was shown as track A004, which was a main rail line,” he said, in accordance with the image  below. “And you can’t park there.” He said that trainmasters would then enter the train as being on tracks C16 or C33, which don’t exist and couldn’t be accounted for in the Canadian National system. (On the image below, Track A004 — shortened to A4 — appears two tracks above A-6 in the upper right-hand corner.)

Sarnia Yard. Source: Transport Canada
Source: Transport Canada


Sarnia’s ghost tracks, as well as the ones a few miles across the U.S. border in the Port Huron, Michigan, train yard, were central to Canadian National’s role in an odd 2010 episode that involved shipping biodiesel back and forth across the U.S. and Canadian borders to take advantage of a renewable energy tax incentive in the U.S.

A railroad’s on-time promise can be translated into substantial money.

A logistics consultant to industrial and agricultural clients throughout Ontario told the Southern Investigative Reporting Foundation that on-time promises are easier to fudge for railroads than for a trucking or air freight company. That’s because, he said, “Federal Express has to get it to your home or office door at a certain time; railroads only have to get it from one terminal to another,” where another train takes it to [a distribution facility] where trucks or ships pick it up.

Practically speaking, overpaying for on-time performance, said the logistics consultant (who wouldn’t consent to his name being used because he said he does business with Canadian National), amounts to paying slightly extra for Canadian National’s so-called Series 100 trains, its fastest freight movers, to depart from one terminal at 5 a.m., for example, when it really leaves at 10:30 a.m.

“Few are going to be the wiser because the trains to the [distribution] facilities always leave hours after the scheduled arrival time,” he said.

Commenting on the money to be had in charging for an arrival at a terminal that may not happen as planned, the logistics consultant said, “If Canadian National, or any railroad, can pick up an extra $50 a car load from a customer on certain trains,” then that would translate into “an easy $50 million per year, maybe more.”

The problem, he concluded, is “the volume customers are the smartest about how ‘the system’ works and have the leverage to strike deals after competitive negotiations.”

The Southern Investigative Reporting Foundation repeatedly sought comment from all the people named in this story. Without exception they declined.

Canadian National spokesman Patrick Waldron was provided with the documents referenced above and declined to comment on questions submitted to him, apart from reiterating the railroad’s comment on the auditor general’s report. He did note that in 2013 Canadian National had issued a public rebuttal to certain claims that Holmes had made in his ongoing litigation.

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Prospect Capital: The Enemy Within

John F. Barry III, the founder, chairman and chief executive of business development company Prospect Capital in Manhattan, can’t seem to get any respect.

In June 2015 Prospect took out an advertisement in Barron’s that sought to attract more investors by touting its then 12.4 percent dividend yield and the share price promptly dropped.  A shareholder wrote a tongue-in-cheek essay calling Prospect “the most hated stock on Wall Street.” Over the past six months both the Wall Street Journal and New York Times have written critically — to varying degrees — about the company’s portfolio valuation and dividend payment practices. Not to be outdone, short sellers, who have had the company in their sights for nearly five years, are broadcasting their own list of grievances about Prospect’s operational and accounting disclosures. Posts about the company or its prospects go up on Seeking Alpha nearly weekly and attract dozens of commenters who weigh in with full-throat for days at a time.

Incredibly, a Well Fargo research analyst has even gone so far as to issue a “Sell” recommendation on its shares.

Why does a company with under a $3 billion market capitalization arouse the passion usually reserved for disputes over so-called battleground stocks like Herbalife or Tesla Motors?

One reason for the intense feelings is attributable to Prospect’s corporate structure as a business development company, an unusual hybrid of commercial lender and investment fund. At bottom, it’s a federally chartered closed-end fund required to invest at least 70 percent of its assets in the debt or equity of small- and medium-sized companies and distribute 90 percent or more of its income to investors. Because of this, a large percentage of BDC investors are attracted by the dividends; in Prospect’s case, the $1 monthly dividend gives its shares just over a 12 percent current yield.

But BDCs also have limits on their ability to pay dividends if the debt-to-equity ratio goes above 100 percent. At quarter’s end on March 31, Prospect’s ratio was 73.8 percent. A BDC not paying dividends would be hard pressed to retain many investors.

There’s a precedent for this kind of fight and it’s the stuff of Wall Street legend: Greenlight Capital’s David Einhorn waged a bitter multiyear struggle against Allied Capital, a BDC that he sold short in 2002 because of what he said were numerous financial irregularities. While Allied eventually was sold to a competitor in 2010 at a fraction of its peak market capitalization, the many millions of dollars of expense Greenlight incurred made it a Pyrrhic victory. (In an ironic twist, shortly before its sale, Allied caustically rejected an unsolicited merger bid from Prospect.)

Based on a Southern Investigative Reporting Foundation investigation into Prospect’s $1.1 billion book of collateralized loan obligation investments, it appears that investor concerns over valuations are well-placed. Then again, the risks to shareholders from incorporating market prices into their CLO portfolio are much less than management’s dexterity with esoteric accounting maneuvers.


Recall that CLOs are special purpose vehicles whose various sections, known as tranches in Wall Street parlance, are fixed-income securities made up of corporate loans. The CLO’s principal and interest is paid from its highest-rated, or most senior, tranches on down; credit losses are absorbed from the bottom up, with the unrated piece — the “equity”– bearing both the CLO’s highest interest rate and absorbing all of its initial credit write-downs. (The CLO’s higher-rated tranches can change hands with frequency but the liquidity of an equity deal is often spotty.)

BDCs like Prospect find CLOs attractive because from a risk perspective, they offer a diversified pool of loans that is higher in the capital structure than corporate debt, enabling them to get paid back first if a default were to happen. Prospect and several rival BDCs have built extensive CLO equity portfolios because given the nature of their structure, the equity tranches can target 12 percent to 15 percent annual returns.

Prospect’s approach to valuing its CLO book has been a source of sustained controversy for the company.

Critics like Wells Fargo research analyst Jonathan Bock, who issued the “Sell” rating in April discussed above, argue Prospect’s peers have shown little hesitation in reducing the value of similarly constructed CLO equity portfolios. He compared Prospect to Eagle Point Credit and highlighted the then 21-point spread between the two: at the end of last year, Eagle Point’s CLO book was valued at 55.6 percent of its estimated fair value while Prospect marked it at 76.3 percent.

While an imperfect comparison, that 20.7 percentage point differential between the two portfolios illustrated the point that the stakes are very real, representing a notional $230 million hit to Prospect’s equity value and the loss of millions of dollars in fee income for its management.

For its part, Prospect has said that it has no control over the actual portfolio valuation process since it’s done under contract by Gifford Fong Associates, a California fixed-income analytics consultancy. It’s an unusual choice: Gifford Fong certainly has an established practice in financial theory and mortgage-backed securities pricing, but based on numerous calls to CLO trading desks and investment managers, no one had heard of it being used to provide pricing. (With no centralized exchange, price discovery in the $881 billion CLO market is usually done using broker-dealer pricing services.)

Fong did not respond to a pair of phone messages and an email.

Nor has Prospect’s management done itself many favors in communicating how it arrives at its valuations, often seeking to redirect questions into discussions about the importance of being the CLO equity market’s biggest investor or the top-ranked collateral managers who structure and issue the deals they buy.

A question during Prospect’s second-quarter conference call last year is illustrative of Prospect’s roundabout way of addressing CLO valuation questions.

On Feb. 5, 2015, Raymond James Financial analyst Robert Dodd asked President and Chief Operating Officer Michael (Grier) Eliasek why four CLOs were sold for losses after being carried on the books at a premium to their acquisition price: “So I mean was there something particularly problematic about these that changed from the end of September to the period when you sold? . . . And I mean is there something we should read into that as to the overall book being marked above par when we’ve got the four most recent cases . . . all marked above par?”

In response, Eliasek said, “I would not read too much into that, Robert, there [are a] few other dynamics at play here,” before discussing how Prospect was in a position to “throw its weight around” and obtain original issue discounts and rebates, which were something that didn’t “travel with the deal” if they sold the paper in the market.

(To be sure, a company’s having a lower cost basis than competitors often makes it an investment incrementally more profitable but such an analysis is not taking into account portfolio valuations.)

Prospect’s management also argues that having what they term a “call right,” where their status as the majority investor in an equity tranche gives them the ability to compel the distribution of the underlying loans to investors, should justify a premium valuation.

But it’s not apparent this is currently applicable given what’s known as “negative net asset value,” where the cost of the equity tranches exceeds fair value, or the estimated price they’d get if they were sold into the market. Based on a survey of the conference-call transcripts of other BDCs that buy CLO equity, only Prospect is making this argument.

Put another way, it doesn’t make economic sense to break apart something that cost $25 when the sum of its parts is worth $23.50. As of the end of the March quarter, according to Wells Fargo’s Bock, 23 of Prospect’s 38 CLOs had negative NAVs.

To see whether Prospect’s CLO equity valuations have reflected prevailing market values, the Southern Investigative Reporting Foundation used trade level indications and bid-list data provided by investment-banks active in the CLO market. In two instances the public filings of Prospect’s rival BDCs were used. To make the process as fair as possible, only trades made within 30 days before or after a quarter’s end were included.

The chart below represents the Southern Investigative Reporting Foundation’s estimate of this valuation differential.

Screen Shot 2016-08-03 at 2.07.45 PM

The Southern Investigative Reporting Foundation found 13 instances where Prospect’s marks differed sharply from the prices other investors were paying for them. This differential started at the end of 2014 and in aggregate suggest that management was able to avoid at least $83 million in portfolio value reductions. (In imposing a 30-day cutoff before or after a quarter’s end, the foundation removed 10 instances of trades done at appreciably different pricing levels but as much as three months after a reporting period.)

For example, in an April 13 email given the Southern Investigative Reporting Foundation, a CLO trader told clients that a customer was offering a block of between $5- and $10 million of a Prospect owned CLO tranche, Symphony CLO IX Ltd., at 54 percent of par value. Prospect, per its 10-Q, valued this CLO at 66 percent as of March 31.

In another instance, on March 22, a broker emailed his clients that the cover bid — the second-place bid in a “Bid Wanted in Competition” auction, usually within 1 or 2 percentage points of the winner — for $2.45 million of the CIFC Funding 2013-III CLO was 43.5 percent; Prospect valued the same CLO at 67 percent on March 31.

Last December a brokerage made a two-way market in the Octagon Investment Partners XV Ltd. equity tranche, offering via email to buy $5 million at 62 percent or to sell the same amount at 65 percent. On Dec. 31, Prospect marked this at 80.4 percent.

It’s a Wall Street truism that an asset is worth only what someone will pay for it, so with a well-established CLO secondary market — even conceding that CLO equity is the least liquid in its asset class — it would appear logical to use market inputs when pricing.

It’s not so clear cut, counseled Mark Adelson, editor of the Journal of Structured Finance and a 20-year veteran of securitized product analysis. Speaking generally, Adelson said that while trade prices are ordinarily a valuation’s primary component, CLO equity’s spotty liquidity means that at least some tranches won’t trade enough and that the theoretical inputs of models are required.

“We’re talking about Level II and III assets here. Trades are very meaningful but there is a risk that the buyer was an idiot, so you can’t turn your back on the model.”

“Then again,” Adelson said, “If you have the ability to discern whether the buyer was [sophisticated] and the markets were orderly, your model needs to reflect those trades.”


Prospect’s shareholders might not have seen the “nasty, brutish and short” fate described in Thomas Hobbes’ Leviathan, but some do have a fair measure of resentment that’s perfectly understandable.

That’s due to Prospect management’s compensation framework, which virtually guarantees that fees grow if total assets under management expands. Based on a management fee of 2 percent of gross assets and an incentive fee of 20 percent, last year Prospect Capital paid Prospect Capital Management — the John Barry-controlled advisory managing its investments — over $225.3 million and the year prior it was almost $198.3 million. An additional $21.9 million was paid to Prospect Administration, the entity set up to manage the BDC’s non-portfolio operations, for a total of just under $247.2 million.

(Privately held, Prospect Capital Management isn’t obliged to disclose what Prospect Capital’s key executives earn.)

On the other hand, Prospect’s shareholders, who have experienced two dividend cuts since 2010 and over 75.8 million of share sold below net asset value, are stuck with this chart.

According to a shareholder lawsuit filed in April in U.S. District Court that is alleging a breach of fiduciary duty against Prospect Capital Management and Prospect Administration, shareholders were inappropriately charged between $54 million and $102 million, depriving shareholders of increased dividends. (In June, Prospect filed a memorandum of law in support of a motion to dismiss.)

To be sure, there’s nothing wrong with a CEO wanting his or her company to grow, and handsomely compensating those who generate increased profits is exactly how the system should work. To that end, Prospect has indeed grown its profits, reporting $346.3 million in net income from 2011’s $94.2 million.

Yet Prospect’s filings suggest that these figures are less a function of shrewd lending choices than they are of a great deal of dilution and burgeoning debt. Consider that in June of 2011 Prospect had 107.6 million shares outstanding and $406.7 million in long-term debt; five years later those totals now stand at 356.1 million and more than $2.95 billion.

When Prospect’s investors tire of mercurial portfolio growth and want higher dividends, they might take a hard look at how they compensate management. Because management is rewarded for growing interest income, rather than on how well the borrower performs, over $1 billion of loans have a payment-in-kind component, where a proportion of an interest payment is made in securities. This increases the net interest income figure, but the benefit is on paper since it brings in no cash. Management, to be sure, gets paid in cash based off a formulation that includes noncash inputs, preventing the company from investing that cash elsewhere.

Last year 8.4 percent of interest income, or more than $29.2 million, was attributable to PIK.


Prospect hasn’t taken the criticism lying down.

CEO John Barry referred to criticisms of Prospect’s business model and accounting as “a smear campaign” this February during a conference call. In December, general counsel Joseph Ferraro wrote a series of letters to Seeking Alpha angrily denouncing Probes Reporter, an institutional research provider whose specialty is using freedom of information act requests to determine if companies are fully disclosing Securities and Exchange Commission investigations, for having written that the company was not being forthcoming about a purported investigation.

Probes Reporter chief executive John Gavin in a brief interview said, “I’ve been doing this for a long time. I stand by our reporting on what [we] obtained from the SEC under the Freedom of Information Act.”

In a March release discussing the dispute with Prospect, Gavin argued that the company had more success with three critical articles published in the Motley Fool last August and September by contributor Jordan Wathen, which no longer appear on its website. Asked to confirm whether the company was behind their removal, Wathen declined comment. The Motley Fool did not respond to an email seeking comment.

The only comment given to the Southern Investigative Reporting Foundation about Prospect and its affairs was John Barry’s curt “Are you really calling me at home” when contacted at his home, followed by “Put [your questions] in an email.” Several follow-up calls and emails were ignored.

Editor’s note: A family member of the author owns Prospect shares in an investment account but did not trade the security before the release of this report.

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Barry Zyskind’s High-Stakes Three-Card Monte Game

A tiny footnote buried in a pair of corporate filings suggests AmTrust Financial Services’ chief executive officer has a great deal of explaining to do about who owns almost 7 percent of the company’s shares.

Barry Zyskind, according to an early January Securities and Exchange Commission Form 4 filing, transferred 12,020,000 million shares of AmTrust — then worth more than $378.2 million — to a “charitable organization” called Gevurah from Teferes, a tax-exempt personal foundation he set up in 2006. (The number of shares reflects a Feb. 15 2-for-1 stock split.) According to the filing, he serves as a trustee and officer for the entity, with voting and investment authority. The company’s proxy, filed on March 29, also mentions this transfer.

Oddly, those two footnotes are the only mentions of Gevurah seemingly anywhere.

The Southern Investigative Reporting Foundation called American Stock Transfer & Trust, the transfer agent for AmTrust shareholders — the Karfunkel brothers founded it in 1971 and sold it in 2008 for about $1 billion — on May 12 to ask if Barry Zyskind had made a share transfer to Gevurah. A company representative told us there was no record for Gevurah in their computer system. (A transfer agent maintains shareholder records and balances for its corporate clients.)

There is no listing of a Zyskind-linked Gevurah foundation in the official record of tax-exempt organizations, the Internal Revenue Service’s Exempt Organization Business master file. Nor was there any success with the Canadian, United Kingdom or Israeli equivalents. (Zyskind, the son-in-law of the recently deceased AmTrust chairman and co-founder Michael Karfunkel, is a supporter of Haredi educational and religious institutions in Brooklyn; many of these institutions have links to Israel.)

Gevurah is similarly absent from the or the OpenCorporates databases; in contrast, Zyskind’s Teferes foundation, his former father-in-law Michael Karfunkel’s Hod Foundation and AmTrust’s other co-founder, Michael’s younger brother George’s Chesed Foundation for America, all show up in both. Foundation Source, a business that provides advisory and administrative services to private foundations, maintains a comprehensive database of public charities called GrantSafe but Gevurah isn’t in it.

To reiterate: Gevurah might exist in some form somewhere on earth but as of this writing, it’s not one with a charitable registration in the United States, at least with that name and connected to Barry Zyskind. The Southern Investigative Reporting Foundation even tried inputting various spellings of its name or searching for a filing made by Zyskind’s family, such as his wife Esther, in each of the named databases above. Finally, none of the Zyskind or Karfunkel private foundations have any alternate names, often referred to as “DBA’s,” that they are doing business under, attached to their registrations.

Regardless of whether it’s an “organization” or foundation, Gevurah needs to be registered somewhere to receive a grant from another public charity, as Teferes’ own registration stipulates.

Earning a fortune is assuredly hard but giving (some) of it away is not, at least if you choose to set up a personal foundation. Getting a nonprofit like Gevurah entered onto the New York state’s books (where Zyskind registered Teferes) is simply a matter of completing a Certificate of Incorporation form and filing some standard bylaws. After applying for and receiving an Employee Identification Number, the foundation can operate without restrictions for up to 27 months as the IRS considers its application for tax exemption. Assuming no mistakes, within about four weeks of filing most charitable organizations are registered.

All of the above costs about $530: $80 for the state and $450 for the IRS.

Possibly the only scenario in which Gevurah could have been granted the shares without potential legal headaches is if it’s considered a place of worship, but virtually all synagogues and churches register so donations to them can be tax deductible. From a practical perspective, a congregation launching with an endowment of this size would be unprecedented.

Zyskind’s Gevurah problems emerge as the SEC has put renewed emphasis on compliance with Section 16 of the Securities and Exchange Act of 1934, a series of rules that mandate company insiders disclose material changes in holdings in a timely and accurate manner. One large law firm called this the “broken windows” theory of securities enforcement. (Mary Jo White, SEC chairwoman, used the phrase in a 2013 speech.) Notably, in September 2014 the SEC’s enforcement unit filed suit against 28 corporate directors and officers, as well as six companies, for such violations.


The ongoing saga of the Karfunkel brothers, Barry Zyskind and their private foundations are a familiar topic to Southern Investigative Reporting Foundation readers.

Per our reporting, the Karfunkel-Zyskind foundations have so much AmTrust stock that they have run afoul of an IRS rule known as excess business holdings that addresses how much of a single company a private foundation can own.

Excess business holdings is the IRS’ framework of rules developed as a response to the practice of some 1960s-era donors who made tax-exempt donations of their shares to private foundations, albeit with a great deal of string attached. Instead of selling the stock and using the proceeds to make grants, these foundations held onto the stock, allowing the donors to maintain control of the company.

To prevent this, IRS rule permits private foundations to hold up to 2 percent of a company’s shares outstanding and levies sharp fines and penalties for non-compliance.

In order to meet the IRS’s rules, the Teferes, Gevurah and Chesed Foundation for America, which currently own 26.6 million shares between them, would be permitted to own 2 percent of the 175,356,577 shares outstanding, or a little more than 3.5 million shares. This means that they would potentially have to sell over 23.1 million shares, a prospective dilution of 13.1 percent. They could do this via direct sales or through unencumbered grants to unaffiliated charities like Habitat for Humanity or United Way, which would likely sell the stock quickly upon receipt.

Being forced to massively reduce their AmTrust holdings — and thus sharply diminishing their voting power — might not be the only migraine in store for George Karfunkel and Barry Zyskind: IRS Section 4943 levies a 10 percent excise tax based on the value of their “peak holdings” within a given tax year. In light of this, based on the Southern Investigative Reporting Foundation’s analysis of Gevurah, Teferes and Chesed Foundation for America’s excess business holdings of AmTrust shares, their prospective liability would appear to be $296.6 million.

Sources: 990-PF filings via and historical prices from Nasdaq
Sources: 990-PF filings via and historical prices from Nasdaq


For over a month, starting on April 13, the Southern Investigative Reporting Foundation repeatedly emailed and called Elizabeth Malone, AmTrust’s investor relations executive. She consistently stated that she “would check” with management about the Gevurah questions but never called back.

The emails to Malone went unanswered.

Calls to Stephen Ungar, AmTrust’s general counsel, and Harold Schlacter, the treasurer, were not returned.

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The Enabler and the Lifeline: Diamond Resorts and Quorum FCU

Purchase, New York, is a woodsy, suburban hamlet on the Connecticut state line that’s known as much for its residents’ extraordinary wealth as it is for being the headquarters address for corporate heavyweights like MBIA, PepsiCo and MasterCard.

The town is also home to Quorum Federal Credit Union, a small member-owned and tax-free cooperative whose website suggests it’s still the type of plain vanilla alternative to big banks that it was set up to be 82 years ago, where profits reduce the cost of loans and boost the interest rate paid on savings accounts.

What can’t be easily seen, however, is the fact that Quorum has become a major lender to the vacation ownership interest business — that is, the new iteration of timeshare sales, the controversial, if long-standing, vacation concept. Loans made to customers of Diamond Resorts International are the biggest part of this portfolio and it’s no embellishment to say that without Quorum, Diamond wouldn’t be where it is today.

(Southern Investigative Reporting Foundation Readers will recall its March investigation into Diamond’s financial filings, revealing a picture that’s entirely at odds with the growth juggernaut that management touts. A January New York Times investigation discussed allegations of high-pressure or misleading sales practices at several Diamond resorts.)

Access to the Quorum lending facility is a key component of Diamond’s business model — the credit union funds loans that are eventually securitized, providing the cash it needs to keep its operations going and to maintain its investment-grade credit rating. To that end, Diamond’s annual report disclosed it extended the lending agreement into 2017 and the loan facility raised to $100 million.

This is not the most favorable moment for a VOI marketer to be looking for replacement financing. Loans are showing mounting delinquencies and more broadly, the industry is coming under renewed regulatory scrutiny. (To that end, in its recently filed proxy, Diamond disclosed that its board of directors has formed a “strategic risk” committee to assist the board in its “oversight of the business, affairs and management of the Company.”)

One former Quorum official told the Southern Investigative Reporting Foundation that with respect to its relationship with Diamond — circa 2014 through early 2015 — their impression was that Diamond sent its “riskier seeming” loans to the credit union. During certain periods of the year, up to 1,000 VOI loan applications per day would come to Quorum “with easily half from Diamond,” they said.

(Diamond has usually been about 30 percent to 37 percent of Quorum’s VOI portfolio, according to its annual reports, but in 2015 fell to 27 percent.)

Additionally, this official recalled many of these loan applicants having FICO scores under 660, a key criteria in determining whether a borrower is classified subprime. They said “most” of these loans were approved as Quorum sought to grow its membership.

Membership is a key concept in keeping a credit union vigorous because unlike a bank, it can’t issue shares or debt, nor have ancillary units like investment management or securities trading.

For Quorum, growing membership — and the assets members bring in the form of checking and savings account balances — was the reason they struck a deal with Diamond in early 2010 in the first place, according to the former Quorum official. Take a look at Quorum’s 2009 call report to see why: a loss of $1.1 million, declines in membership and assets, and a spike in loan delinquencies.

The deal provided up to $40 million worth of loans for Diamond and in return the borrowers would become members of Quorum. But joining a credit union requires people to have a common professional or vocational bond, like working at a specific employer or in a certain industry. Quorum threaded this needle by having borrowers sign a document that made them a member of the American Consumer Council, a consumer advocacy group with an “affiliate relationship” with Quorum. After the VOI borrower is a member, per the Diamond contract, Quorum would seek to market other types of loans to them.

For every loan application Quorum approved, according to the former Quorum official cited above, Diamond purportedly deposited $25 in the borrower’s savings account.

American Consumer Council president Tom Hinton, in an email comment about the use of his group’s affiliate relationship as the first step in a VOI loan process, said, “I appreciate you bringing the matter of time share loans to my attention. While ACC does not make consumer loans, if consumers are being manipulated or abused financially, we are very concerned. Let me investigate this matter further and be in contact with you shortly.”

At the center of Quorum’s VOI loan strategy is the Vacation Ownership Funding Company LLC, or VOFCO, an entity 79 percent owned by Quorum and 21 percent by its president and founder, Todd Fasanella. Known as a credit union service organization, or CUSO, VOFCO consults with Quorum on VOI loan sourcing and portfolio management, although being more specific than that is difficult because after being prominently mentioned in the front of recent annual reports, it’s not referenced again.

Whatever VOFCO does, it does well, at least in the eyes of Quorum’s president and chief executive officer, Bruno Sementilli. When the NCUA floated a proposal to expand CUSO disclosures in August 2011, he felt strongly enough to pen a bluntly worded letter in opposition. Referencing VOFCO, he wrote, “in less than two short years, we estimate our credit union has earned over $4 million dollars in loan interest and generated $60 million in member deposits.”

He added that VOFCO is “an innovative enterprise, borne out of the ashes of the credit crunch, [that] required non-disclosure agreements from many parties.”

Tracking VOFCO’s contribution to Quorum’s bottom line is difficult since the credit union stopped breaking out its performance in the second quarter of 2011. The last call report with VOFCO’s earnings was the end of the first quarter in March 2011 and it showed a loss of $283,000, an improvement over the prior quarter, the end of the fourth quarter in December 2010, which disclosed a loss of $1.5 million. The most recent call report only noted that Quorum had loaned VOFCO and its four other CUSOs a total of $1.9 million; other documents appeared to suggest that much of this total was to VOFCO.

VOFCO’s chief executive Todd Fasanella is also a full-time investment banker at Beverly Hills-based brokerage Imperial Capital. It’s an unusual arrangement for Wall Street circa 2016: he works at Imperial advising or trying to drum up business from VOI industry clients and then turns around and manages a $158 million portfolio of their loans for someone else.

Multiple attempts to contact both Imperial’s general counsel and president to discuss Fasanella’s two jobs were unsuccessful.

In a prior job as an asset-backed securities banker at Credit Suisse, one of Fasanella’s key clients, National Century Financial Enterprises, perpetrated a massive fraud. Briefly, NCFE’s senior managers inflated the amount of receivables NCFE had purchased from medical practices and then, using the proceeds from securitizations of the bogus receivables, sent payment “advances” to health care providers they owned undisclosed stakes in.

When the scam unwound in the autumn of 2002, Dublin, Ohio-based NCFE was accused of collecting $2.5 billion from two dozen institutional investors; when the bonds were revealed to be nearly worthless, the losses spread to several brokerages, including Credit Suisse. Two of the company’s senior executives were sentenced to 25- and 30-year jail terms and another four executives were convicted.

While no regulator or client accused Fasanella or his Credit Suisse colleagues of perpetrating or aiding the scam, a U.S. District Court judge had some sharp words about what they saw and said about NCFE internally.

In a 2012 opinion denying Credit Suisse’s motion for summary judgment on the NCFE bondholder’s claims, Judge James Graham of the Southern District of Ohio, cited emails and depositions from Fasanella and three Credit Suisse ABS unit colleagues as evidence of their possibly “having knowledge of the fraud.” He also wrote that there was evidence that Fasanella, at varying points, may have been aware of a series of NCFE’s problematic business practices, including “using reserve funds to buy receivables” and management’s attempt to manipulate (downward) the receivables default rate.

Credit Suisse settled the NCFE noteholder claims in May 2013 for $400 million.

Reached on his mobile phone, Fasanella sole comment before hanging up was “I don’t speak to reporters.”


Diamond has a good thing going with Quorum: They get access to ample credit, especially for those applicants with weaker credit profiles. From a Diamond investor’s perspective, it would be a shame if anything changed.

This week Quorum posted its first-quarter call report, and it’s safe to say that change is in the offing after it disclosed $6.8 million in bad loan charges that led to a loss of $2.99 million.

The post-credit-crisis strategy of focusing on esoteric lending opportunities like VOI (as well as taxi medallions, hearing aids and fertility treatments) to generate revenues and membership has run into both a broader slowdown in the consumer credit cycle as well as more specific problems, like an increasingly worried regulator.

Since 2014 Quorum’s regulators at the National Credit Union Association have been scrutinizing its VOI loan portfolio. They are weighing (among other measures) ordering the credit union to sell up to $110.7 million worth of VOI loans that it’s holding in a held-for-sale account.

According to Quorum’s 2015 annual report, another $47.9 million of VOI loans are held in the consumer loan receivable account. All told, the credit union has a total of $158.6 million worth of these loans, making up 22.6 percent of the $701 million loan portfolio.

Almost 14 percent of the VOI loans were in arrears last year — in 2014 it was 12.6 percent — and Quorum says it hasn’t reserved for prospective losses given its “credit enhancement feature,” or the discount between the loan’s full value and the price it pays for the loan, which last year was between 80 percent to 90 percent of full value.

If the NCUA ordered Quorum to sell the VOIA held-for-sale block, it’s difficult to imagine the loans fetching a price the credit union would be happy about because there is no secondary market for this type of asset, so any bid would likely be below the value that they are carried on Quroum’s books, diminishing equity.

Keith Leggett, a retired American Bankers Association senior economist, has written about Quorum and VOI loans repeatedly on his weblog, Credit Union Watch. Asked about the likelihood of the NCUA forcing the credit union to sell the loans, he said, “I would have thought it was a low probability outcome, but [the NCUA] is clearly reconsidering their approach to the loans based on the annual report’s language.”

He did add, “If [Quorum] was forced to do so it wouldn’t be like a margin call from a broker; they would almost certainly be given a good amount of time to work out a solution.”

(A brief disclosure: Leggett worked for the Washington-based ABA, the banking industry’s primary trade and lobbying group, whose membership is a daily competitor of credit unions for consumer deposits. Moreover, its leadership has recently sought to end tax exemption for credit unions. Going back decades, the ABA and credit unions have disputed a host of financial regulations.)

One headache that Quorum won’t be able to navigate around is the $76 million taxi medallion loan portfolio. Though not explicitly referenced in the first-quarter call report, the loan charge-offs are almost certainly coming from here.

As the popularity of cab alternatives Uber and Lyft continues to skyrocket, taxi industry revenues have plummeted. Correspondingly, medallion prices have currently fallen to around $500,000 from under $1.1 million in 2013.

Morgan Stanley’s equity analysts, in a March 31 research report on Signature Bank, estimated that a baseline default scenario for taxi medallion loan portfolios is 25 percent, with a worst-case scenario of 50 percent (playing out over four years).

What’s this mean for Diamond? Quorum’s management may want to continue lending heavily to the VOI industry, but equity write-downs from medallion losses might force regulators to curtail activity.

A credit union is considered “well capitalized” if the ratio of its net worth to total assets is 7 percent or better; Quorum’s ratio is 7.3 percent this quarter. If the Morgan Stanley baseline scenario comes to pass, and total assets don’t grow appreciably, that ratio would drop to 5.1 percent, making Quorum “undercapitalized.”


Over the course of five weeks’ worth of reporting, numerous phone and email attempts were made to contact Quorum Federal Credit Union’s management, especially its president and CEO, Bruno Sementilli, and this included trying his home and mobile phone numbers.

Similarly, attempts to obtain a comment from Vacation Ownership Funding Company’s chief investment officer, Greg Cooper, failed.

After being asked about its relationship with Quorum Federal Credit Union, Diamond Resorts provided these answers.

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Globus Medical’s Inside Job

In February of last year spinal orthopedic device maker Globus Medical purchased Branch Medical Group, a key supplier and contract manufacturing operation based just 3 miles away from its Audubon, Pennsylvania, headquarters.

The BMG deal was announced on the same day Globus released fourth-quarter and 2014 earnings and little attention was paid to what looked like another instance of a high-profile, larger company merging with a small, privately held one.

But with a $52.9 million all-cash price tag, the purchase of BMG was not so small for Globus, which had just reported $474 million in sales for the prior year. Moreover, it was no ordinary deal: In the bloodless language of business law, the BMG purchase was known as a related-party transaction. On paper, as referenced in several annual reports, the families of Globus’ top three executives owned 49 percent of BMG and management enthusiastically proclaimed a good opportunity to take control of the production process. In reality, however, a stroke of the pen allowed those same Globus executives to legally transfer $25.9 million in shareholder cash to themselves.

(It should be noted that while the majority of related party dealings — where the company conducts business with insiders like board members and senior executives — are often as benign as employing an executive’s son or daughter, they have also been at the center of numerous instances of self-dealing and abuse.)

As far as the Securities and Exchange Commission is concerned, the BMG purchase was legal and met the requisite disclosure standards. Since the 2012 initial public offering filing, Globus had acknowledged that the families of its chief executive officer David Paul and senior vice president of operations David Davidar, as well as former president and chief financial officer David Demski, owned the 49 percent stake in the then-unnamed “third-party” supplier.

It’s how very little the disclosure rules really mandate that should trouble Globus investors.

A Southern Investigative Reporting Foundation investigation found that the purchase price — it increased in under eight weeks to $68 million — is very difficult to explain when compared to what a Globus competitor paid for a key vendor under two years prior.

BMG has a host of other issues that merit investor concern, including the undisclosed financial relationship between David Paul and BMG’s ex-CEO and the inability of the supplier’s supposedly remarkable margins to meaningfully contribute to Globus’ earnings.


While the concept of purchasing a key supplier has merits in a time when insurance plans are forcing a movement to capitation, or flat fee payments per patient — thus setting off concentric rounds of price-cutting throughout the health care system — Globus’ BMG deal has a big head-scratcher: the price.

Unusually, the $52.9 million price in the February press release became $68 million when the Proxy was filed in late April, a 22 percent increase. The reason given: working capital adjustments from $9 million additional cash in a BMG bank account and $5 million in accounts receivable. To be sure the deal’s legal provisions did note that the price was “subject to adjustment to certain working capital items.” Most every acquisition has a provision for it — examples include tardy customers finally paying up or some inventory getting written down as a project is cancelled.

A 22 percent working capital adjustment upwards, however, would appear to be exceptionally rare.

How so? One of the first things the suitor verifies in the due diligence process is cash balances. Obviously any company would want to know what’s in the bank; less obviously, cash accounts have often been the proverbial canary in the coal mine with respect to operational or governance problems. Inexplicable swings up or down in cash balances, or large payments to or from unknown entities, can suggest a host of looming problems. So this part of the vetting process often gets granular quickly as one team of finance executives grills the other about the minutiae of their payment cycles and receivables portfolio payments.

For a company that did $21.9 million in revenues in 2014, $9 million cash is a great deal of money to surface over an eight-week period. The Southern Investigative Reporting Foundation sought clarification from Globus on the specifics of the working capital adjustment.

Globus president Anthony Williams, in answering a question about the working capital adjustments, took exception to the Southern Investigative Reporting Foundation’s characterization of the BMG deal’s price as having increased. He said the net expense to Globus remained $52.9 million given that the $9 million in cash, $5 million of accounts receivable and another minor adjustment effectively canceled the roughly $15 million price spike. (See his full answer here.)

In any event, by several yardsticks the BMG deal is remarkably expensive.

At the time of purchase BMG had $24.3 million of net assets — $14.9 million of which was plant, property and equipment — and over 60 percent of the allocated purchase price was goodwill. Despite interviews with former BMG officials who point to the supplier’s equipment being both modern and well-maintained, at the end of a day, paying over 2.5 times net assets for a contract manufacturer is considered remarkably expensive.

Looking at the purchase another way, during the Globus conference call discussing 2014 annual results, the interim chief financial officer David Demski said Globus planned on pumping “approximately $15 million to $17 million” into BMG to double its “sourcing.” If taken as an approximation of replacement value, this implies that between $15-$17 million would allow someone to replicate the supplier’s existing production capacity. So a $68 million price means that Globus paid 4.3 times replacement value. Investment bankers who work in the medical manufacturing sector told the Southern Investigative Reporting Foundation that twice replacement value is standard.

Then there are transactions within Globus’ marketplace.

NuVasive, a Globus competitor in the spinal orthopedic market, beat it to the punch when it purchased one of its own key contract manufacturers, ANC, in 2013 for $4.5 million. ANC is about two-thirds BMGs size, with 65 employees and 35,000 square feet of production space to BMG’s 110 staff and 50,000 square feet. Their economics were broadly similar, according to their last available financial filings — ANC did $19.5 million in revenue in 2013 and BMG reported $21.9 million in 2014.

Globus’ Williams said that an independent committee of Globus’ board of directors had hired Houlihan Lokey to do a fairness opinion. The investment bank concluded that comparable transactions were done between 5.5 times and 7 times 2014 EBITDA, making the BMG deal, he said, at 5.7 times its EBITDA a bargain for Globus shareholders.

The Southern Investigative Reporting Foundation asked Williams for a copy of Houlihan Lokey’s fairness opinion and received no reply; he was also asked why Globus, unlike many other companies, didn’t include a copy of the opinion when the merger documents were filed. In reply he said, “In my experience we took all of the steps that would be appropriate for an acquisition of this nature.”

A call to Houlihan, which does not list the BMG deal on its website’s list of advisory clients, was not returned as of publication time. (Williams’ full response is here.)


Buying BMG created an interesting dynamic rarely seen in the world of mergers and acquisitions: a husband and wife on the opposite sides of the negotiating table. While this sounds more dramatic than it likely was, David Paul’s wife, Sonali Paul, was the designated shareholder representative for BMG’s investors, according to the merger agreement; she was also BMG’s designated representative.

There is some evidence to suggest the deal had been long planned for. Spine Therapy Technologies LLC, the North Carolina holding company she used during the BMG sales process, was created in January 2014. Don Reynolds, the lawyer from Raleigh, North Carolina’s Wyrick, Robbins, Yates & Ponton law firm who set it up, is a longtime Globus adviser who was listed on its IPO prospectus (and Anthony Williams’ former law partner).

In response, Williams said that the use of entities like Spine Therapy Technologies is standard in mergers and that Don Reynolds’ law firm had represented BMG since its inception. (See here for his full response.)

One oddity of the merger has been BMG’s minimal contribution to Globus’ bottom line, despite having disclosed $9.1 million in adjusted EBITDA in 2014. IBMG’s 39 percent adjusted EBITDA margin was almost three full percentage points better than Globus’ so it should have been an immediately visible contributor to profits.

Using pro-forma numbers, released in Globus’ quarterly filings which include BMGs results, the supplier would have added only $816,000 in income in 2014. That’s a difficult number to understand — assuming a standard 35 percent corporate tax rate, and eliminating interest (BMG had no debt) this leaves only depreciation as a culprit, but a three- or four-year depreciation schedule on modern equipment is very unusual.

Asked about this, Williams said, “The profit and loss benefits take time to realize based on accounting principles. As we’ve publicly stated on several occasions, BMG’s profit becomes part of Globus Medical’s inventory and is recognized on our income statement as that inventory is sold.” (See his full statement here.)


BMG began life as BCD Manufacturing Group LLC in March 2004, started operations the following year with a $2 million loan from Globus and was located in Globus’ headquarters building for five years; in February 2008 its name was changed to Branch Medical Group. (Anthony Williams, then a lawyer for the Wyrick, Robbins firm above, handled the paperwork.)

Through March of 2009, David Paul was BMG’s president and CEO. Within a year after Paul stepped down, his wife Sonali, as well as David Davidar’s wife Janet, became board members. David Demski, who would become Globus president and chief operating officer, was also a BMG board member and its treasurer.

Globus classified BMG as a variable interest entity, meaning that the supplier’s revenues were kept on its books — but presented separately. That changed in late December 2009 when an investor — the company refuses to disclose who — made a $2 million investment and the company became independent.

After Paul gave up BMG’s helm in March 2009, Mahboob Khan, a childhood friend of his, moved to America and was appointed the supplier’s choice. Despite the pair’s personal bonds, he was not an intuitive choice to run a a complex orthopedic device business, having run a shoe business in India. In reply to a question about Khan’s qualifications to run BMG, Williams said, “Mr. Khan did much more than just run a leather shoe factory in Chennai. Mr. Khan’s expertise was in a large-scale manufacturing operations supplying a global market. He ran factories with thousands of employees.” (See Williams’ full reply here.)

Khan and Paul must be truly close friends because when Khan and his wife bought a very attractive 7,900 square foot house in Phoenixville, Pennsylvania, on 2.5 acres, Paul co-signed two mortgages worth $836,000 (one for $804,000 and another for $32,000). In May 2011, when Khan refinanced the property, Paul assigned his one-third interest in the property to Khan and his wife for $1.

A personal guarantee of the magnitude Paul extended Khan could have conceivably raised questions about Khan’s ability to aggressively stand up for BMG’s interests.

The reason relationship wasn’t disclosed, according to Williams, is because Paul did not pay any amounts under the initial mortgages and he had only co-signed in the first place because his friend didn’t have the requisite credit history to obtain a loan.

Khan had an ownership stake in BMG, Williams said, but he declined to specify how much. Pressed on why its owner group remained hidden, Williams said the supplier had goals of doing business with other large medical device manufacturers and its owners argued to Globus that publicly disclosing their relationship in the IPO prospectus might alienate prospective customers.

As it emerged, BMG had few customers, prospective or otherwise, apart from Globus which regularly accounted for between 90 percent to 95 percent of its revenues, according to Securities and Exchange Commission filings. (See Williams’ full response here.)


The Southern Investigative Reporting Foundation spent a week seeking answers to its questions via phone and email from a series of Globus executives named in this story, as well as Brian Kearns, its new investor relations chief.

(If Kearns’ name seems familiar, it’s likely because of the 2009 SEC complaint brought against him related to his stint as CFO of MedQuist, a failed medical billing operation. As part of a settlement, he paid $50,000.)

Neither Sonali Paul nor Mahboob Khan replied to a series of detailed voice messages left on their mobile phones.

In fact, no Globus executive replied to messages sent to them except Anthony Williams. He gave these answers to questions posed to him.

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The Cost of Standing in the Gap

The Southern Investigative Reporting Foundation needs your help.

After launching the foundation in 2012, the board of directors and I have sought at every step of the way to adhere to the mission statement:

“Our investigative foundation will produce substantive reporting infused with valuable information and a perspective quite distinct from the glossy outlook spun inside Wall Street’s promotion machine. We will mine corporations’ legal and financial documents and perform old fashioned shoe leather reporting to frame investigations that many media organizations are simply no longer equipped to pursue.”

I argue that we are meeting that goal. Moreover, the slate of coming investigations is sure to be the most high-profile work yet. Trust me on that. But a key aspect of our ability to constantly report out and write pieces that afflict the rich and powerful is having comprehensive insurance coverage in place.

That’s getting harder and harder to do.

Over the past several months, as I began to gather quotes prior to renewing our insurance coverage, something became brutally apparent to me: our approach to investigative reporting had scared the living tar out of insurance companies.

Our core insurance coverage has gone to an $8,000 annual premium from under $2,000 — and we are informed that number will increase. The deductible has gone to $50,000 from $10,000.

Consider that out of more than one hundred insurance companies that offer so-called custom liability policies like error and omission — more informally known in the press as “libel coverage” — only three said they would even consider extending a quote to the Southern Investigative Reporting Foundation. (Then and now it struck me that to insurance underwriters, North Korea’s airline and its shipping are acceptable risks, but a small investigative reporting outfit in North Carolina is simply too toxic.)

Ultimately only one company did manage to extend a quote, but only after the Institute for Nonprofit News’ then director Kevin Davis freaked out at its underwriters, threatening (in a truly memorable email thread) to pull several dozen INN member policies at once. When the huge premium increase was quoted, he ordered INN to write the check on the spot to cover it. I asked why he was doing this and he explained, bluntly, “What the fuck do I or INN exist for apart from standing in the gap for those who stand in the gap?”

I am confident that Kevin Davis gets what the Southern Investigative Reporting Foundation is trying to do.

Every Southern Investigative Reporting Foundation story bears the potential for legal threat and a good deal of them eventually result in one. When I worked for large media companies like Euromoney, News Corporation or Time Inc., I didn’t have to pay much attention to the amount of threats and subpoenas I received (and I got more than a few); editors and management seemed to like the fact that a reporter was stirring things up and it was generally perceived as being good for business.

A key requirement of the Southern Investigative Reporting Foundation’s insurance policy is that every legal threat has to be reported, no matter the source or how unlikely they are to ever follow through. Here’s an example of a legal threat that came from our Medbox series; here’s another from our Brookfield investigations. Don’t forget this unpleasant legal interlude last year that emerged from our reporting on inventor, investor and spaceman extraordinaire Anthony Nobles.

The world has changed. Think of the papers and magazines of your youth and then look closely at them now. Growing up in the ’70s and ’80s my parents always had a subscription to Time magazine and I read it religiously, thinking maybe one day I could be one of those reporters on Capital Hill or in places like Lebanon or Taiwan, reporting on the events that drove the world forward.

This is Time today, aggregating news that others reported (who themselves often rely on newswire stringers) on the view that your lingering a few more minutes to watch a funny video or click on a celebrity story can eventually be monetized in some fashion.

Let me ask you a question. Whatever else its attributes, do you think Time magazine’s current management would commit the resources to a yearlong investigation into Scientology that resulted in this article? The five-year legal battle with the Church of Scientology cost Time Inc. many millions of dollars in legal fees and subscriptions but its employees, lawyers and managers (broadly) considered it a badge of honor.

Those men and women are long gone from that building now.

The Southern Investigative Reporting Foundation is designed to have few friends and allies — outsiders and skeptics rarely do — but I’m asking those who value our work to consider using Paypal to make a tax deductible donation to help us meet our insurance premiums so we can continue to generate accountability-oriented investigations.

Standing in the gap, doing the reporting others can’t or won’t, is not supposed to be easy. There’s no real money in this — here’s our financial filings — and we win no awards and precious little acclaim. Filing a good story about what other didn’t see or didn’t know about is usually enough.

Our payment deadline approaches and we must meet it or we need to go away. The cost of standing in the gap is high and getting higher. It’s almost like someone or something doesn’t want us to do this work.

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Diamond Resorts and Its Perpetual Mortgage Machine

Roddy Boyd-3
Illustration: Edel Rodriguez

Since 2007 the website of Diamond Resorts International has made people think their personal six-night stay in heaven is only a few clicks away.

Online the company’s resorts, full of beaches and golf courses, still beckon. But Diamond is a 21st-century timeshare operation and investors ought to be wary of any company using the controversial vacation concept that has provided decades of fodder for comedy writers while troubling state and federal regulators.

Indeed what Las Vegas-based Diamond is selling is a sleeker, more expensive iteration called a vacation-ownership interest or VOI. And it seems to have proved successful for Diamond, at least thus far.

As is the case with buying a timeshare, customers purchase from Diamond the right to an annual one-week vacation at a resort. There are some important differences, though: Customers aren’t receiving a deeded right to a week’s stay at a specific resort. Rather, they gain the right to stay at a collection of company-owned properties in the United States, South America, Europe or Asia.

They can also buy a membership in a “trust” that allows for stays at other venues: When buying the vacation-ownership interest, they receive “points” that can be redeemed for a week’s stay — even at resorts and on cruises with which Diamond is affiliated but doesn’t own.

The concept of points is key. Think of them as a virtual currency, albeit one for which Diamond is both the dealer and the Federal Reserve. Purchasing more points means that a member has greater latitude to book a vacation, especially during peak seasons. It also means that the customer has spent a good deal of money.

In contrast, having a lower point total may require a member to reserve certain properties as much as 13 months in advance. Determining the price of points is part of the VOI negotiation process when a new member signs up. Thus, a point does not have a fixed dollar value: A chart, with data culled from member lawsuits against Diamond, seems to indicate that over the past three years the dollar value of a point has been trending lower.

Customers can expect to pay about $26,000 for a VOI for one week a year and about $1,460 in annual maintenance fees.

And a VOI is a so-called perpetual use product with a lifetime contract that’s difficult for a member to be extricated from — and there’s no resale market that he or she could tap for cash. The mandatory five- to 10-day cooling off period after a member first signs up is the only chance a customer has for canceling the contract before entering a lasting financial commitment to Diamond. (The company has said it may make some modifications to this policy in the future.)

Diamond faces considerable challenges in selling its main product — the VOI — given the current economics of the travel industry. Travel websites and apps like, and Airbnb frequently let would-be vacationers procure the equivalent of a Diamond resort stay for less than the company’s annual VOI maintenance fees. Many Diamond resorts even allow nonmembers to reserve rooms through consumer travel sites. But when a member relies on Diamond’s financing (banks don’t do VOI financing), this can push the combined annual maintenance fee and loan-payment expense to more than $6,000, a mighty price tag for a week’s stay.

Diamond disagreed with this assessment, arguing at length that focusing solely on cost sacrifices the value of convenience and flexibility.

One fact that Diamond’s management might not dispute is the warm reception investors and brokerage analysts have bestowed thus far. Rare indeed is the brokerage analyst who has not been impressed by Diamond has sustained growth trajectory: The company booked more than $954 million in sales last year, a spike from 2012’s $391 million.

And Diamond’s share price has steadily ticked northward, from $14 during its July 2013 initial public offering to $35 a year ago. This resulted in a $2 billion market capitalization when the company’s shares reached their peak value in February 2015. For the founding management and investment group that still owns more than 35 percent of the shares outstanding, this translated into over a $600 million stake at that time.

Yet in late January, a New York Times investigation showed that some of Diamond’s rapid growth might be due to overly aggressive sales practices. The Times article roundly spooked investors and almost $300 million of market capitalization was lost for more than three weeks before Diamond’s share price recovered. In response, the company issued a press release emphasizing its “zero tolerance” policy toward misleading sales tactics.

The Southern Investigative Reporting Foundation spent two months investigating Diamond’s murky soup of public accounting and disclosures to explore the financial mechanics of the company’s success. This investigation found that the financial statements have a very large red flag.

Simply put, there are a lot of close parallels to how subprime mortgage finance companies rapidly expanded in the last decade. The most obvious similarity lies in the drive to ensure a steady stream of borrowers whose down-payment cash will keep a company operating.

Diamond faces four interconnected problems: The company cannot survive on the amount of cash sales it makes, so it needs to finance sales. Diamond has to securitize those loans to bring cash in the door or run the risk of losing money on every sale. To retain favorable terms for monetizing its debt, the company has to use its own cash to make up shortfalls in the securitization pools. Since the realized value on customers’ loans is less than the amount Diamond has borrowed against them, it needs to monetize new loans faster and faster.

Recent history suggests that the fate of a company like this is not pretty.

(In an effort to provide readers a clearer view of Diamond’s responses, the company’s replies in full to specific questions have been embedded throughout this story. Of special interest are the replies supplied on Feb. 11, Feb. 12, Feb. 16, Feb. 17 and March 4.)


Since 2011 Diamond has experienced a decline in its VOI sales to new members as a percentage of the company’s entire VOI sales (although the percentage did modestly increase last year from 2014). According to the just-filed 10-K annual report for 2015, 21 percent of last year’s VOI unit revenue came from new members. In 2011, that figure was 34 percent. What’s the reason for the broad decline? It’s not immediately clear.

Diamond dismissed a reporter’s recent question about the possibility of a decline in VOI sales to new members, citing the dollar growth of their purchases. (The estimated dollar value of new member sales did increase to about $148.1 million last year from $135 million in 2014.)

By contrast, new members at Diamond’s two biggest rivals, Marriott Vacations Worldwide and Wyndham Worldwide, accounted for 36 percent and 32 percent, respectively, of their companies’ VOI revenues last year.

Common sense would suggest that absent large blocks of new members arriving organically or through a purchase of a rival company, Diamond’s continually pushing current members to upgrade their VOIs will eventually result in diminishing returns.

In addition, the number of “owner families” has decreased in three of the past four years. As owner families drop away from Diamond, the prospect of enticing existing members to upgrade their vacation owner interest becomes threatened. Diamond stopped reporting the number of owner families in the third quarter of 2014 without notice. An archived investor-relations Web page from June 2, 2015, tallied the number of owner families at 490,000, which is a decline to the level in early 2013.

Source: Diamond Resorts SEC filings
Source: Diamond Resorts SEC filings


When asked why the company abruptly stopped disclosing the number of “owner families” in its public documents, Diamond replied that it has stopped providing the number because a large amount of its paying customers are hotel guests or use a so-called timeshare exchange network like RCI or Interval.

CEO David Palmer’s remarks about industry consolidation made during the company’s third-quarter conference call this past fall seemed to indicate that Diamond might be seeking additional acquisitions. When Diamond released its annual earnings report in late February, however, the company disclosed it had retained Centerview Partners to “explore strategic alternatives” — Wall Street shorthand for seeking a buyer.

Selling a company when its revenue grew at almost 12 percent last year and net income more than doubled is an unusual approach for a board of directors to take, especially since the shares nearly 50 percent off their highs. Managers with conviction about company prospects would ordinarily be seeking to add capital and expand the business or to borrow money to take the firm private.

Instead Diamond’s leaders seem to want an exit. What follows below is probably the reason why.

The 2015 10-K shows 82.8 percent of VOI sales had what the company calls “a financing component,” which can be compared with 38.6 percent in 2011.

Figures are expressed in thousands. Source: Diamond Resorts SEC filings
Figures are expressed in thousands.
Source: Diamond Resorts SEC filings

The trend over the second half of last year is even more pronounced: In the third quarter, customers relied on company financing for 84.3 percent of VOI purchases. And in the fourth quarter, 83.4 percent of VOI purchases were financed this way.

Why should shareholders be concerned that almost 83 percent of Diamond’s customers last year borrowed money for their week in the sun? Because the credit crisis of 2008 is evidence that consumers with high fixed-cost debt can, in the aggregate, do grave damage to a company whose sales are reliant on financing.

When one checks numbers culled from Diamond’s November securitization, it takes little imagination to see how a VOI membership can quickly turn into a dangerous burden for a consumer. Consider this: The average loan in this securitization pool is for $24,878. When that amount is coupled with an 14.31 percent interest rate for a 10-year term, this locks a member into a $391 monthly payment. That’s $4,692 annually for the member — with at least another $1,000 in annual maintenance fees. (The 2015 10-K said the average VOI transaction size in last year was $26,007 and the average down payment was 20 percent, or $5,201.)

Diamond told the Southern Investigative Reporting Foundation that these are not regulated loans like mortgages but rather so-called right-to-use contracts it described as a prepaid subscription product without a real estate component.

(It’s worth noting that several paragraphs disclosing potential risks for investors were added to Diamond’s new 10-K about the potential for expanded Consumer Financial Protection Bureau regulation of VOI sales.)

Diamond argued in its filings that other members of the VOI industry offer their customers financing. But unlike Marriott Worldwide Vacation and Wyndham Worldwide, which financed 49 percent and 61 percent of their VOI sales last year, respectively, Diamond’s customer base appears to be dependent on it.

Make no mistake: Offering customers financing of as much as 90 percent of the price of a VOI has enabled Diamond’s rapid sales growth. With the amount of cash sales a paltry 16 percent to 17 percent in the second half of last year, this kind of financing keeps a stream of money from down payments flowing.

So to ensure working capital and manage risk, Diamond set up a securitization program. Chief Financial Officer Alan Bentley explained why securitization is crucial to the company’s needs during a presentation in March 2015, shown on page 21 of the official transcript:

“If I use an example that the customer did a $20,000 transaction with us, they’ve made a 20% down payment, which means we did a $16,000 loan. . . . Well, that 50% is on the $20,000 transaction, right. So you look that and say, ‘Okay, you got — you did $20,000 deal,’ you’ve got $10,000 out of pocket because you’re paying for your marketing costs, you’re paying for your sales commissions, et cetera. So that part’s out-of-pocket. So effectively, you’re upside down. Remember, so you got $4,000 down got $10,000 out-of-pocket. So how do we monetize that and get the cash? During the quarters, what we will do is remonetize that by placing those receivables into a conduit facility. Now that conduit, of course, is we have a $200 million facility and that $200 million conduit facility is we will quarterly place those receivables into that conduit, for which we receive an 88% advance rate, right. So we get that cash back at that 88% level on that — on the conduit.”

Whatever Diamond borrows from the conduit facilities is repaid when it securitizes its receivables.

When one looks from a distance, the program seems to have put Diamond in a virtuous cycle — of issuing high-interest, high-fee loans bringing in interest income and freeing up cash for its sales force to secure additional sales.

Moreover, the bonds that emerge from these securitizations have performed well to date. Then again, they should: Diamond typically has the option to repurchase or substitute in a new loan when a loan defaults (and use its own cash to make up a shortfall). According to the Kroll Bond Rating Agency, “Diamond has historically utilized these options resulting in no defaults on their securitizations.”

These VOI loans do have one truly unusual characteristic, though: Diamond’s members are paying off the loans much faster than their rivals’ customers. Wyndham’s VOI loans are paid off on average in about four years; Diamond members are paying off their loans in about 1.4 years. (In 2011 Diamond’s members retained a loan for about 2.4 years on average.)

But the problem with virtuous cycles is that they can spin the other way, too. If there are broad economic problems, borrowers might start wrestling with job losses or wage pressures and then the speed of prepayment might sharply decline. When that happens, typically the number of loans in arrears increase. If the prepayment speeds stay lower for long enough, Diamond — which has used its own cash and fresh loans in the past to help the loans in the securitization pools avoid defaults — might have to come up with a serious cash injection.

Diamond said its asset-backed bonds are prepaid so quickly because its customers tend to make VOI purchases while on vacation and, upon returning home, quickly pay off the loans.

SIRF’s reporting, laid out in detail below, suggests an entirely different answer.

After weeks of investigation, the Southern Investigative Reporting Foundation came across an obscure accounting rule called Accounting Standards Codification Topic 978, which went into effect in December 2004, that allows Diamond — or any timeshare company — to recognize revenue from upgraded sales even if the member doesn’t put any money down. New-member sales, in contrast, are accounted for only when at least 10 percent of the VOI’s value has been received.

If ASC 978’s logic is counterintuitive to outsiders, for Diamond’s management it is surely heaven sent. On the view that a timeshare purchase is a real estate transaction, an upgrade to a vacation ownership interest is considered a “modification and continuation” of the existing sales contract.

How does this work in real life? Say a new member purchases his or her VOI for $20,000 and puts $4,000 down, a 20 percent equity stake. If six months later that member seeks to upgrade to an expanded membership level that costs $20,000 and signs a sales contract to that effect, Diamond could account for this as a sale even if no money is put down.

That 20 percent equity stake, which is really now 10 percent given the $20,000 additional financed, is all the legal cover the Diamond accountants need since the upgrade is considered a modification and continuation of the initial timeshare purchases contract. Diamond’s computers can now record a new $36,000 loan to pay off the initial $16,000 loan and book $20,000 in new revenue. This appears to be why Diamond has such high prepayment of its loans.

If the whole things seems circular, that’s because it is. A lending facility that Diamond controls loans an existing member $20,000 and it goes on the books as revenue but not a penny of cash has gone into the coffers — yet. Plus, that initial $20,000 loan is now accounted for as fully repaid even if it is not: The member still owes $36,000 plus the hefty interest rate. And it’s completely legal.

So who is responsible for this accounting stroke of genius? None other than the senior accounting staff from the timeshare industry’s leading companies who proposed this new rule in 2003.

At the very minimum, ASC 978 should give investors pause about Diamond’s quality of earnings.

When asked if the new accounting rule had spurred the high prepayment speeds of its loans, Diamond pointed to its customers’ creditworthiness as the cause.


Evidence is beginning to mount that some of Diamond’s borrowers are struggling with their obligations. Less than two weeks ago, Diamond disclosed a 45 percent increase in the amount of its provisions for uncollectible sales revenue in the fourth quarter of 2015 to $24.8 million from $17.1 million a year prior. In the company’s release, the jump was attributed to a change of certain portfolio statistics during the quarter,” suggesting some degree of credit performance woes.

The Southern Investigative Reporting Foundation asked the company to elaborate on the “certain portfolio statistics” that proved nettlesome and in a lengthy answer, it ignored the request to discuss the specific statistics behind the spike in uncollectible sales reserves but merely referenced issues that might have informed its decision.

Nor is that the only data point that suggests looming headaches. The default rate on Diamond’s loan portfolio last year was 7.7 percent, the highest the company ever reported.

Source: Diamond Resorts SEC filings
Source: Diamond Resorts SEC filings


Analyzing the health of Diamond’s loan portfolio is not a cut-and-dried exercise: Its rivals, Marriott Vacation and Wyndham Worldwide, wait 150 days and 90 days, respectively, before they charge off their bad loans; Diamond uses 180 days, a full two months longer.

Asked about why the company waits 180 days, Diamond said it’s a matter of internal policy and that there is no rule governing time frames for charging off bad loans.

The more Diamond’s securitization program has expanded, the deeper underwater the company has become. In 2011 it reported $250.9 million in securitized notes and funding capacity against $270.2 million in receivables. This means that if the company had to pay off its bonds, it had a nearly $20 million surplus of money owed it to draw upon.

As the securitization program doubled in size, however, that surplus evaporated. Last year Diamond borrowed $642.8 million against a net receivables balance of $604.5 million, amounting to a $38 million deficit. In other words, Diamond would have to come up with cash rather than substituting loans to make its bondholders whole. (The Southern Investigative Reporting Foundation excluded adjustments because they were noncash accruals and assumed that receivables that weren’t securitized have a zero net realizable value, otherwise the $38 million deficit would be greater.)

During the same five-year period, the average seasoning of loans (the amount of time that the loans are kept on Diamond’s books before they are placed in a securitization pool) dropped to three months last July from 25 months in an April 2011 offering.

Figures are expressed in thousands. Source: Diamond Resorts SEC filings
Figures are expressed in thousands. Source: Diamond Resorts SEC filings


Editor’s note: When the Southern Investigative Reporting Foundation first approached Diamond for a comment for this story by phone and email on Feb. 5, Sitrick & Co.’s Michael Sitrick responded as the company’s outside public relations adviser on Feb. 13. While his firm has a diverse and high-profile practice, Sitrick is traditionally associated with crisis communications. He also served as the outside spokesman for Brookfield Asset Management when it threatened to sue the Southern Investigative Reporting Foundation in February 2013.

Two Southern Investigative Reporting Foundation board members (while working for previous employers) have written about high-profile Sitrick & Co. clients like Biovail, Fairfax Financial Holdings and Allied Capital.

Correction: A previous version of this story mischaracterized a letter written by the VOI trade association to the Consumer Financial Protection Bureau. The related paragraph has been deleted.

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Valeant Pharmaceuticals: The Great Wellbutrin Channel Mystery

With Valeant Pharmaceuticals’ evolution from battleground stock to full-bore Wall Street circus, it is easy to forget that underneath the competing valuation narratives and regulatory drama is a real operating company.

The odd thing is that down at the operating level — where drugs are made, shipped to market and sold — things don’t get very much clearer.

One of Valeant’s more enduring riddles is the continued vitality of Wellbutrin XL, a drug that has been off patent since 2006. A January Bloomberg News article ably laid out Valeant’s strategy of constantly raising prices on the drug — 11 times since 2014 — that underscores how revenue jumped.

But looking at Wellbutrin XL’s prescription count data from the second and third quarters last year — specifically the reported revenues — some unanswered questions remain.

For instance, the third-quarter Wellbutrin XL prescription data captured by Symphony (and available via a Bloomberg terminal) indicated that the count declined by 2,743 prescriptions, to 67,312 from 70,055.

The decline in Wellbutrin XL’s prescription count makes plenty of sense since there are numerous factors working against the brand — the aforementioned price increases and additional generic competitors hitting the market after the Food and Drug Administration put to rest bioequivalency concerns.

What doesn’t make sense is how revenues increased 37.3 percent sequentially, jumping to $92 million from $67 million. It seems we can rule out Direct Success, the Farmingdale, New Jersey-based specialty pharmacy that fills Wellbutrin XL prescriptions for low (or no) patient co-pays and then works to secure reimbursement, as the channel for the difference.

While Direct Success is the obvious candidate to explain any discrepancies since data reporting services don’t capture specialty pharmacy prescription activity, Valeant itself ruled this possibility out when spokeswoman Laurie Little told Bloomberg News, “[Direct Success] accounted for less than 5 percent of Wellbutrin XL sales.” She also remarked that there were other channels where the drug is sold, including “Medicare, Medicaid and the Department of Defense.”

It is very unlikely that these channels factor into the Wellbutrin XL issue. Centers for Medicare & Medicaid Service contract awards are heavily contingent on price and the Department of Defense even more so; many Medicare Part D plans don’t even cover the brand. Here is a DoD contract out for bid, for example, and here is the (generic manufacturing) winner.

(As the Southern Investigative Reporting Foundation was finalizing reporting on this article, Wells Fargo research analyst David Maris released a report that mentioned Wellbutrin XL’s unusual performance in the third quarter of 2015, among numerous other issues. While ordinarily it would be unusual to be beaten to the punch by a sell-side analyst, Maris is an exception, having — ironically — caught Valeant’s corporate forbear Biovail Pharmaceuticals in a revenue inflation scheme. In full disclosure, I also reported frequently on Biovail, a legendarily clogged corporate toilet.)

One area that merits consideration is some sort of channel stuffing, wherein distributors are sold more drugs than they can presumably sell themselves.

Consider pharmaceutical distributors, who have very narrow operating margins (given the nearly riskless nature of their business) and whose business model benefits mightily from distributing drugs where price increases are regularly announced. This allows them to purchase drugs in advance of the scheduled increase and profitably resell them at a higher price.

For a manufacturer, aggressively moving extra inventory into distribution channels bears little risk: The profit on incremental volume moved is huge and it is effectively zero-interest financing since the company gets cash up front and simply return it to the distributor if product is unsold. The risk is that a manufacturer’s distribution networks have too much of a product and sales decline until inventories clear out. To be sure, there is a long history of pharmaceutical companies improperly handling the accounting related to drug distribution.

Inventory reduction has certainly been on Valeant management’s mind.

At a December analyst meeting in Newark, then-chief executive officer Michael Pearson spoke about “bringing down the inventories in the wholesale channel,” “the continued impact of the reduction in channel inventories” and referenced getting “normalized in 2016.”

Valeant’s days sales outstanding do appear high as the chart below indicates, even adjusting for the inventory that came on balance sheet in April when the Salix purchase closed. (In December, the Southern Investigative Reporting Foundation released an investigation into Valeant’s unusual Eastern European distribution practices.)

Sources: Bloomberg and SEC filings
Sources: Bloomberg and SEC filings


On Friday afternoon the Southern Investigative Reporting Foundation submitted questions via email to Valeant outside spokeswoman Renee Soto of Sard Verbinnen & Co. She did not reply by press time.

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Valeant Pharmaceuticals: Howard Schiller, Up in the Air

Shortly before 11 p.m. on Feb. 4, Valeant Pharmaceuticals CEO Howard Schiller took off from Dulles International Airport for home. It had been a long, tiring day of preparation, congressional testimony with plenty of blunt questioning and afterward came the inevitable debriefing with his legal and public relations advisory team.

It was not a lost day, though: Speculators in Valeant’s shares perceived Schiller as having done well and the stock price closed up $3.87, an unexpected development when a CEO is called to account for his company’s business model. He certainly helped his cause when he flatly admitted the company made mistakes and understood the pain its drug pricing policies had caused.

To be sure, it did not go flawlessly — there were several broadsides landed from the likes of U.S. Rep. Elijah Cummings, the head of the House Committee on Government Oversight and Reform panel that subpoenaed him. And a day earlier the Democratic committee staff had posted a letter — culled from discovery in the Committee’s ongoing investigation — with several deeply unflattering references to Valeant’s business practices.

Still, whatever else that day brought Schiller, it can be safely assumed that had the representatives known he flew home on Valeant’s G650, the world’s most expensive private jet, not even sitting next to a smirking Martin Shkreli — whose colleague was castigated for acknowledging Turing Pharmaceuticals threw a $23,000 party for its sales force on a yacht — could have shielded him from some populist outrage. (Congress has a track record of criticizing executive’s private jet flight at companies under investigation.)

This is Valeant’s G650:

Screen Shot 2016-02-21 at 3.24.30 PM

So Schiller’s flight home was good. He did not have to sit on plastic seats waiting to be boarded by zones; he just walked right onto the plane. Nor did he have to shimmy into a closet-sized restroom that smelled like a mashup of Lysol and Mennen Speed Stick. There was plenty of leg room and he was always free to move about the cabin. In case he wanted a snack, the refrigerator has its own IP address that communicated its inventory to the D.C. based ground crew who restocked it prior to takeoff.

Exactly 57 minutes after takeoff Schiller landed at the Morristown, New Jersey, airport, a 20-minute car service ride to his home in Short Hills. Flying home at over 500 miles per hour, Valeant’s newly appointed CEO went from Dulles’ suburban D.C. tarmac to his northern New Jersey house in less time than he would have been inside an airport prior to boarding a commercial flight.

Flight records reviewed by the Southern Investigative Reporting Foundation suggest Schiller has quickly grown fond of the G6, having flown three times in the past month with his family and friends to a small regional airport in Montrose, Colorado, near his Telluride ski house.

Those drug pricing policies that necessitated Schiller’s D.C. interlude have made Valeant a great deal of money, or at least enough to maintain a fleet of three Gulfstream jets: a G4, G5 and G6. The G5 and G6 are owned through a company subsidiary, Audrey Enterprise LLC. It keeps them in Morristown, 23 miles away from its U.S. headquarters in Bridgewater.

Valeant is hardly alone in having a fleet of its own planes but it certainly chose from the high end of the menu. The G6 cost just under $65 million when it was delivered in 2013 and the G5 was about $59 million in 2012. It costs between $2 million and $3 million annually to staff, insure, house and maintain the three jets before variable costs like fuel — a 1,000-nautical mile trip in the G6 uses about 860 gallons — and cabin crew. When under way, the cost per hour is about $4,500 for the G5 and G6 and around $3,400 for the G4, although the recent drop in fuel prices probably puts these figures on the high side.

Under the best of circumstances a company extending its leadership the personal use of a major corporate asset like an aircraft can be fraught with potential headaches. At the top of that list is what happens when that company comes in for some bad publicity; then there is what happened to Valeant, which has become a corporate pariah.

Most chief executives would be hard-pressed to afford regular personal travel aboard a Gulfstream or its equivalent but Schiller’s personal financial situation is not like most chief executives. A Goldman Sachs partner at the time of its 1999 initial public offering — where his 0.375 percent stake became $61.87 million in cash — chartering his own plane isn’t likely beyond his means. His salary is $4.8 million and he currently holds a little over $36 million in Valeant shares.

Valeant’s 2014 proxy statement explicitly permitted Schiller’s predecessor Michael Pearson — who is still on medical leave and recuperating in his New Vernon, New Jersey, home — to use company aircraft as he saw fit. In 2014 it valued this use at $195,614 (although it stopped paying his taxes for these flights.) Schiller’s employment agreement does not mention aircraft use but in the proxy he and Pearson were the only executives with personal use allowances.

On Friday a Valeant spokeswoman, Renee Soto of Sard Verbinnen & Co., was emailed a pair of questions about “the optics” of flying back from the congressional hearing on a G6 as well as Schiller’s personal use of company aircraft. She did not reply.

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Mr. Schiller’s $9 Million Worth of Reasons to Work Cheaply

Valeant Pharmaceuticals is the type of company that tends to make even the simplest things complex.

The contract of Howard Schiller, its new chief executive officer, is proof of this tendency.

On Jan. 6 Valeant’s board of directors gave Schiller the role of interim CEO; the company previously had an hoc, three-man “office of the chief executive”created on Dec. 28 in the wake of the disclosure that founder and then CEO J. Michael Pearson had taken a medical leave of absence of indefinite duration.

Notwithstanding the fact that Valeant has become the most closely followed company in the capital markets — attributable in part to the Southern Investigative Reporting Foundation’s revelations of its hidden ownership of Philidor — it was reasonable to have expected a filing several days after Schiller’s appointment that disclosed relevant compensation package details.

But that announcement came only on Feb. 1, three weeks after Schiller assumed control.

Schiller’s July 17 separation agreement sheds some light on why he ran a besieged company for over three weeks without an employment agreement in force. Recall that the then CFO resigned in April (after the high-profile Allergen acquisition bid collapsed) to pursue other interests.

The July agreement paid Schiller $2,500 per month for consulting and allowed 100,000 “performance restricted stock units” to vest on Jan. 31, 2016, giving him over $9 million worth of reasons to work (temporarily) for less than the salary of an assistant manager at a fast food restaurant. Each unit converts into one freely tradable share.

Why Valeant would not state that Schiller’s employment agreement would be disclosed after his 100,000 units vested is unclear. An email seeking comment from the company’s public relations adviser, Sard Verbinnen’s Renee Soto, was not responded to.

From a narrow point of view, Schiller’s new contract appears fairly standard; it paid him $400,000 per month for a two-month term ending on March 6. What happens then, however, is unclear. It certainly opens up a Russian nesting doll of questions: Is Michael Pearson seeking to return? If so, will there be disclosure about the root causes of his multi-month absence? If he can’t or won’t return, what criteria is the board of directors using to evaluate Schiller over a 60-day period?

Despite Schiller’s having $9 million in salable stock and a handsome salary on top of that, the money is unlikely to be much comfort for Schiller, given the looming date of his Feb. 4 for his appearance before the House Government Oversight and Reform Committee to answer questions about Valeant’s drug pricing strategy A Feb. 2 memorandum from the committee’s Democrats suggests that Schiller’s welcome will not be a warm one. Containing some unflattering excerpts culled from the more than 75,000 documents Valeant produced in discovery, it shows, among other things, that the company pursued transactions simply for the ability to raise prices. The memorandum did not try to hide the Democrats’ contempt for Pearson, mentioning him eight times in the seven-page document.

Corrections: The initial version of this story misstated the value of Howard Schiller’s restricted stock unit grant and inaccurately connected him to Valeant’s brief-lived office of the chief executive. The story has been corrected and updated. 

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The Brotherhood of Thieves: Insys Therapeutics

Executives at Insys Therapeutics have continued to pressure its employees to develop new ways to mislead insurance companies into granting coverage to patients prescribed its drug Subsys, even as the Food and Drug Administration’s Office of Criminal Investigations is issuing a stream of subpoenas to former employees.

As reported in a December Southern Investigative Reporting Foundation story, Insys’ prior authorization unit (also known internally as the insurance reimbursement center) employees were trained and rewarded for saying anything, including purportedly inventing patient diagnoses, to get Subsys approved. The revelations illuminated the answer to the conundrum raised in our previous stories: How does a company marketing a standard fentanyl spray formulation, under a strict FDA usage protocol, easily double the insurance approval rates of its more established competitors?

Internal Insys documents and an audio recording of a prior authorization unit meeting show that as recently as the late autumn executives were frantically brainstorming new ways to get around increasingly stringent pharmacy benefit manager rule enforcement.

“[Pharmacy benefit managers] had begun to deny Insys’ [prior authorization] requests in the early autumn to the point where it was rare to get more than two dozen approvals per week for the unit,” said ex-prior authorization staffer Jana Montgomery (a pseudonym) and something that began to accelerate after the CNBC reports came out.

“That’s a big change from each employee getting 25, at least, per week.”

Unlike their sales unit colleagues, Insys prior authorization staffers can’t call on long standing professional relationships with prescribers or use speakers program cash to win business. They are hourly workers — albeit among the higher paid prior authorization staff in the medical industry — dealing with other hourly workers and both have little latitude to depart from established scripts. If the pharmacy benefit manager denies the coverage, Insys has few levers to pull, apart from beginning an appeals process.

As critical reports began to pile up in the press, particularly a November CNBC investigative series — and with at least a half-dozen state and two concurrent federal investigations ongoing — insurers began to deny authorization for Subsys.

By the spring Montgomery said that it was clear to everyone in the unit that something had to change or the business would grind to a halt. One big problem was that insurers appear to have gotten wise to what was known internally as “the spiel,” a script of dubious answers to pharmacy benefit manager employee questions designed to clearly suggest the patient had been diagnosed with breakthrough cancer pain (while not coming right out and saying so).

Put bluntly, with state and federal subpoenas becoming a common occurrence, the prior authorization unit could no longer afford to push the legal limits of word games. On the other hand, simply reporting an off-label diagnosis was an unpalatable option given that under 3% of Insys’ patients had cancer.

So Jeff Kobos, the prior authorization unit’s new supervisor, wrote a new version of the spiel that was alternately called “Statement 13” or, in a homage to its confidential nature, “Agent 14.” It tried to thread a needle, designed to navigate both elevated pharmacy benefit manager scrutiny and the rising level of compliance oversight required, while still allowing the unit’s employees to try and guide pharmacy benefit managers to an approval.

The problem being, according to Montgomery, is that the prior authorization unit had gotten behind the curve.

“If you’re doing a prior authorization it should always be straight forward and exactly what the provider gives you,” she said. Pharmacy benefit managers “learned to approach [Insys] with questions that had non-negotiable answers like, ‘On what date did the patient receive their original cancer diagnosis?’

“We didn’t figure that out right away and kept on submitting requests for authorization which were all quickly rejected.”

So like many corporate outfits the world over, the prior authorization unit held a meeting to discuss how to get better results (where “better results” was defined as getting people to think patients with back or leg pain had cancer.)

The Southern Investigative Reporting Foundation obtained a recording of this meeting, held in November.


The initial speaker (and the clearest voice) is prior authorization executive Jeff Kobos who makes a pair of important admissions: At the 2:20 mark he acknowledged the unit’s pattern of dishonesty by saying “when we were using [insurance codes for cancer-related pain diagnoses] for non-cancer [pain].” At 4:30, he made jokes referring to “sandwiches” and “the sky is blue” as the kind of conversational gambits they should try to deflect pharmacy benefit manager worker questions with.

At 5:00, David Richardson a trainer with the prior authorization unit, suggests dropping the “Agent 14” spiel since it wasn’t working. A minute later, he and his wife, Tamara Kalmykova, an analyst with the prior authorization unit, begin to discuss an idea he had in response to so-called smart-scripting, whereby employees of a pharmacy benefit manager use software analysis to determine if a patient — per the FDA’s protocol — had tried another fentanyl drug.

(Montgomery said smart-scripting was another development that Insys’ prior authorization staff couldn’t readily steer around.)

Richardson suggested patients use a coupon for a free-trial prescription of Cephalon’s Actiq. The patient wouldn’t pick the drug up but it would register in databases and allow prior authorization staffers to plausibly claim that the patient was in full compliance with regulations.

But smart-scripting wasn’t the only new obstacle that unit staffers were encountering. Humana, Silverscripts Medicare and other pharmacy benefit managers started requiring not only Actiq or Depomed’s Lazanda, a nasal spray, but the previous use of other major painkillers like morphine, oxycodone and hydromorphone. Still others were calling prescriber offices and confirming every aspect of the diagnosis, including prior history with fentanyl and other opioids.

Adding in a variable like the delivery system (lozenges, nasal spray or inhaler) did offer Insys an opportunity to claim that its patients could only tolerate oral inhalers. Montgomery said pharmacy benefit manager questions about prior use of Lazanda, for instance, were handled by noting the “provider states patient cannot tolerate inter-nasal spray.”

Unfortunately for Insys’ shareholders, the hard line taken with its prior authorization unit is having a very real effect on prescription count, according to IMS Health data.

Source: IMS Health
Source: IMS Health


The number of Subsys prescriptions filled in the third quarter dropped about 4 percent from second quarter levels and the erosion accelerated in the fourth quarter, falling an additional 11%.

Thus far in January, the new year has not brought much in the way of promise, with the 815 prescriptions reported for the week ended Jan. 15 down 6 percent from the comparable week a year ago. Subsys’ share of the transmucosal immediate release Fentanyl market, which hovered near 50 percent for most of the summer, has now fallen below 45 percent.


Jana Montgomery was given a pseudonym because of her cooperation with an ongoing federal investigation. Her account of prior authorization unit practices was read to two of her former co-workers who agreed with her characterization of “the spiel” and declining pharmacy benefit manager authorizations.

As is the case with prior Southern Investigative Reporting Foundation investigations, everyone named in the story was called repeatedly on mobile or home phones and left detailed messages about what we sought comment for. When possible an email was sent as well. As of publication, no one replied.

A detailed message was left on Insys general counsel Franc Del Fosse’s mobile phone seeking comment on these subjects. As of press time the call had not been returned.

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Murder Incorporated: Insys Therapeutics, Part II

The Insys that investors loved and that made its founder and chairman John Kapoor a billionaire is going away and, despite heroic efforts by company officials to rebrand it as a research and development-driven shop, its future will probably be less profitable, with little of the mercurial growth and compounding profits that defined its first four years.

The Southern Investigative Reporting Foundation interviewed two dozen then-current and former Insys Therapeutics sales staff, as well as six doctors and their staff, and their accounts paint a uniformly grim picture of the company’s prospects.

Its forecast is murky because the number of prescriptions for Subsys, Insys’ sole commercially viable product, is dropping and likely to continue to do so.

The forces arrayed against Insys, from a federal grand jury investigation in Boston to, as described in a Dec. 3 Southern Investigative Reporting Foundation story, mounting insurer scrutiny of Subsys prescriptions, represent brutal, if not possibly insurmountable, obstacles. A quick glance at Insys’ financial filings from 2012, when it was committed to marketing primarily to oncologists, is proof that playing by the rules is not very lucrative.

IMS Health data through late November, though, shows a 10.4 percent decline quarter to quarter in Subsys prescriptions. Even allowing for the traditionally soft Thanksgiving week, this is a grim trend for a company that regularly receives about 99 percent of its sales from Subsys.

   Source: IMS Health data through Nov. 27, 2015
Source: IMS Health data through Nov. 27, 2015


Dan Brennan, Insys’ new chief operating officer, seemed to reference the drop-off  when he tried to rally the troops at a Dec. 3 analyst presentation by alluding to some unspecified “commercial opportunities . . . that can stabilize and grow scripts.”

Insys’ decidedly mixed third-quarter earnings report offered a clear sign of the company’s headaches. The seemingly impressive third-quarter revenue figures were boosted by $6.6 million in distributor shipments, which risk “stuffing the channel,” decreasing future sales and profits. More positively for the company’s prospects, lower unit demand of about 5 percent was offset by an $8.4 million gain from ​diminished rebate amounts and higher drug ​prices.

Absent this $8.4 million benefit, Insys would not have been able to report $91.3 million in revenue, allowing it to claim that it had beat the brokerage community’s $83 million consensus estimate.

Flagging sales, however, are nothing compared to what the looming Department of Justice settlement negotiations might bring.

Ready comparisons for Insys’ situation are hard to come by. The only analogy might be Purdue Pharma’s 2007 $600 million settlement with the Department of Justice for intentionally misbranding OxyContin. (Three Purdue Pharma executives also pleaded guilty and separately paid a combined $34.5 million in fines.)

Brokerage firm analysts expect Insys to pay a fine and perhaps agree to amended business practices, a standard ​ritual over the past decade for U.S. businesses accused of wrongdoing. Despite some shockingly large fines and settlement, especially for pharmaceutical firms, the process of writing a huge check and issuing a guarded, conditional apology (without admitting or denying anything specific) is made more palatable for companies as investors often bid up their share prices on the view that “the bad news is now behind them.”

Research by the Southern Investigative Reporting Foundation suggests Insys’ case may be somewhat different.

Former employees say that about 90 percent of Subsys prescriptions were for off-label uses. This happened as a prior-authorization unit executive (and her supervisor) allegedly spent the past three years developing new and improved ways for employees to gull insurers with misleading patient diagnoses and codes, as the Dec. 3 article described in detail.

With the company’s achieving market-leading prescription-approval rates of 85 percent to 90 percent, the alleged scheme of Insys’ prior-authorization unit easily cost insurers hundreds of millions of dollars. They are unlikely to write off these losses without a fight.

Moreover, federal prosecutors will seek recovery on behalf of their employer, the U.S. government. Data obtained via the Freedom of Information Act shows that nearly 25 percent of Insys’ $576.5 million in revenue for Subsys since its launch, or $144.1 million, comes from Medicare and Tricare. While not every prescription was unlawful, with a potential fine of $10,000 per violation, the ones that were could result in an eight-figure company liability.

One saving grace for Insys may be its decent cash position at the end of the third quarter, with just a tad less than $94 million in cash and equivalents available and an additional $61.5 million in short-term investments.

The graph below captures what almost four years of Insys’ selling Subsys off label across the United States looks like.

Sources: IMS Health and FDA Adverse Events Reporting System data through June 30, 2015
Sources: IMS Health and FDA Adverse Events Reporting System data through June 30, 2015


Here the Southern Investigative Reporting Foundation plotted IMS Health’s prescription counts for Subsys adjacent to the FDA’s Adverse Events Reporting System data listing fatalities for which Subsys was listed as the probable candidate for triggering an adverse reaction.

This FDA data is not definitive, as it relies on informal assessments by medical professionals that are voluntarily reported. (An Insys press release last week took exception to the Southern Investigative Reporting Foundation’s reporting and offered its own interpretation of what the FDA data means.)


For more than nine months the Southern Investigative Reporting Foundation has documented Insys’ freewheeling, compliance-light approach to selling Fentanyl. In the course of this reporting, it became clear that Insys’ approach to building and managing its sale force was both the key to its explosive growth and its subsequent woes.

The experience of Insys salesman Tim Neely, a 43-year old former fireman from San Clemente, Calif., is illustrative of how good intentions and honest ambition can be thwarted by a company’s drive for expanding earnings at all costs.

The Southern Investigative Reporting Foundation began talking to Neely while he wrestled with the company over a bereavement leave dispute in the late summer. In October Insys fired him. He has retained a labor lawyer and, in his words, “is examining his options.” In short, Neely is by no means a neutral observer.

Nonetheless, in addition to talking on the record, Neely provided documents, texts, emails and personal notes taken during calls with managers. Anything he discussed was checked with current and former Insys sales reps and managers, several of whom also provided documents. Finally, a reporter spent four days in California and confirmed and corroborated his account.

All signs point to the fact that Neely was a very good sales rep for Insys.

Based on the value of prescriptions, he ranked within Insys’ top 15 sales representatives last year, an achievement good enough to place him in the “President’s Club,” with one perk being an all-expenses-paid Mexican beach junket with other sales leaders. This is noteworthy considering the fact that he began selling pharmaceuticals only in October 2013.

Neely told the Southern Investigative Reporting Foundation that he earned $207,000 last year and, based on the documents he provided, he was on track to earn $170,000 to $180,000 this year.

A proud daily surfer, Neely would tell beach buddies and his family in emails and texts that he had taken a lot of risk leaving the job safety and camaraderie of the firehouse for Insys but that he was doing well and felt good about helping people who were in pain.

But late last summer Neely changed his mind in a big way about Insys.

While remaining a “true believer” in Subsys’ potential as a drug (a broken back a few years ago made him an expert on breakthrough pain, he said), Neely started to become troubled about the integrity of Insys’ management.

Neely said he felt management pushed the sales force to market Subsys “to anyone with a prescription pad.” Anyone who disagreed with that approach, he said, “was treated like garbage” and eventually fired.

His customers were several veteran surgeons who prescribed Subsys with regularity. Based on Neely’s documents and notes, he did what Insys trained him to do — become nearly indispensable to his clients. He instructed patients on the proper use of the drug in doctors’ offices and worked to overcome numerous impasses between patients and insurance companies. His doctors liked him enough to regularly allow him inside their office suites if he needed to make calls to schedule other appointments.

Like many a sales rep in any field, Neely hustled to keep his doctors happy. In one case, Neely arranged the weekly rental of a Beverly Hills basketball court for a regular pickup game with a doctor and his friends; in another, he celebrated a doctor’s birthday with sushi and tickets to a Los Angeles Kings hockey game.

And plenty of prescriptions were written, so much so that Neely said he takes pride in never having asked a doctor to prescribe the drug. The prescriptions were (usually) for cancer and postoperative trauma patients, keeping him far away from legal headaches.

But, as he described it, that wasn’t good enough. Insys’ management wanted more and wished him to somehow try to persuade the doctors to move the prescribed dosage to 800 or even 1,200 micrograms, even if the patient was doing well at 400. To Neely, doing so was destined to hurt patients and strain lucrative relationships.

“Serious doctors don’t want criticism on their dosing [protocols] from a sales rep and they don’t need [Insys’] speaker program money,” Neely said. But “the crappy ones” will and do, he added. “There’s just a point where you can’t sell more Subsys without crossing some lines. It’s not a [skin care] product; it’s not like other drugs.”

Neely and other former Insys reps described the pressure to constantly land new prescribers as unrelenting. Company departures became the norm, with many seasoned pharmaceutical sales reps leaving within weeks of being hired.

The pressure to generate sales revenue often reached absurd levels, according to one former Insys sales manager who for a decade had sold pain-management drugs at other companies. He said the sales leads the company gave his representatives were culled from a database like the yellow pages and had no connection to pain management or oncology. At varying times, his reps were asked to call on a naturopathic healer, a self-described shaman, several chiropractors and a nurse midwife, none of whom were able to prescribe Fentanyl — let alone needed to, he said.

His complaints to management were ignored. After concluding that there was no real business plan, this sales manager resigned three months later.

Another distinctive feature of life at Insys, Neely said, was adapting to what he described as a form of corporate schizophrenia: “Sales training and company-wide phone calls would be by the book, exactly like Merck or someone might do. Then your [district and regional] managers would pull you aside and tell you, ‘Don’t worry about that. Just sell. Do what you need to do.'”

The “say one thing, do another” culture became apparent early on to Neely.

During his training week, after a series of discussions on Subsys’ chemistry, how it compared to rivals and its place within the transmucosal immediate release Fentanyl  marketplace, Neely and his sales trainee colleagues were told they were taking a test the next day — and failure would result in dismissal. A few hours later, a regional manager emailed them the answers to the exam — and the group was taken out drinking until the early morning by sales managers.

A core part of Insys’ sales training involved discussion of the company’s policy against wining and dining prescribers. Shortly after attending that presentation, a still green Neely wound up one night with a prescribing doctor (and his troop of thirsty friends) drinking and smoking cigars at a swank Beverly Hills club. The $530 bill was handed to him straightaway and he paid.

Pharmaceutical companies now disclose what they spend on physicians, either in terms of speakers program fees, research payments or hospitality, per the Physicians Payment Sunshine Act. No record of Neely’s boozy evening has been disclosed.

A few days after his Los Angeles outing, a district sales manager, Darin Cecil, told Neely that since that doctor was a good prescriber, the company kept a credit card available to help pay for just those expenses. Cecil told Neely that this had to be done “quietly” (he was given the card number via a text message) but a sales rep could use it to order sports and concert tickets. And a sales rep could be reimbursed for other events, too. Just as long as prescriptions were written afterward, Neely was told, no one would have any problems with the practice.

Through this hidden reimbursement channel Neely expensed thousands of dollars in entertainment charges — and he was not the only one, according to his former Insys colleagues. Neely said he was led to believe that then CEO Michael Babich knew about the practice but Neely was instructed to never bring it up publicly.

Neely was reimbursed for his charges every time.


While Neely might not have been aware of what other sales reps across the country were doing to sell Subsys, he readily said, “I certainly felt some of the stuff [management] said was OK to do was probably not.”

One controversial practice that Neely described was the following: Sales reps were told to seek permission from staff in doctors’ offices to go through patient files looking for likely Subsys candidates, which, depending on the circumstances, could be a violation of patient privacy standards under the Health Insurance Portability and Accountability Act.

“They treated HIPAA like it was a joke,” Neely said, describing how sales reps, managers and their assistants regularly sent one another emails discussing patients’ treatments, including their diagnoses and dosages. Neely’s files are indeed full of Subsys user data.

Insys had some reasons for that. The prior-authorization program allowed Insys access to patient data so the company could try to secure insurer payment — and the sales rep was usually the point of contact for the patients, telling them when coverage was approved, about next steps, or if coverage was declined, how to initiate an appeal.

The procedures before the weekly sales conference call in Neely’s district illustrate how Insys’ real-time data collection, when combined with the patient disclosures from the prior-authorization program, could lead to potential disclosures of personal health information, according to Neely. Prior to the start of the call, Neely’s district manager would send an email detailing a list of prescriptions that had not been renewed or picked up or that had been canceled, indexed by the prescribers’ names. The idea was that the sales rep would call the prescribers to try to work for a renewal of the prescription or reverse a cancellation.

What was unsaid was that the sales reps likely knew — or at least could take an educated guess about — the names of many of those patients from the prior-authorization process. This led to, in several instances, sales reps’ contacting the patients directly and  encouraging them to ask the prescriber for another, stronger Subsys prescription.

Then there were the episodes so far outside industry norms that they appeared surreal to Nealy.

At a cocktail party during a 2014 sales retreat, according to three of the attendees, one sales manager told her colleagues about an NBA star who had been prescribed Subsys for postoperative pain. This revelation stunned those who had heard it into silence until one wag remarked, “Well at 800 micrograms for 90 days, I guess, he won’t be back for the playoffs.”

In another instance, the Southern Investigative Reporting Foundation obtained a text from a pharmacist who sought a manager’s help locating an Insys sales rep named Brook Spangler. The text described how Spangler had purportedly — and inexplicably — been given a patient’s Subsys prescription but had not dropped it off.

(Contacted for comment, Spangler denied every aspect of the story: “I have never had a patient script in my hands, ever.” When read the contents of the text, she said it was a mistake. Messages left for the pharmacist were not returned.)


The Insys executive who suggested examining patient files — albeit with the permission of office staff — and the biggest proponent of using a so-called secret credit card for entertainment expenses was national sales chief Alec Burlakoff.

Burlakoff’s vision for sales reps at Insys pushed the boundaries of pharmaceutical sales. He wanted them to be so integral to the patient’s experience with Subsys that a doctor would not think of prescribing other drugs. Sales representatives who had worked under him said his rationale for searching through patient files was that it was a win-win proposition: Insys could get additional prescriptions written and the doctor could receive speakers program fees.

A man of incalculable energy and a dynamic speaker, Burlakoff has been a frequent focus of Southern Investigative Reporting Foundation reporting on Insys. His effect on new sales reps was, as Neely put it, “incredibly powerful.”

Also powerful was the effect of his sales policies upon Insys’ income statement. As Burlakoff departed in July, annual sales were anticipated to be $300 million; when he became sales manager in early 2013, the company had just reported about $16 million in revenue.

By the time Burlakoff was lecturing Neely’s late October 2013 training class on his sales views, his strategy was generating tremendous returns in the form of double- and triple-digit quarterly sales increases. So when he spoke, everyone at Insys listened.

“If you can keep [patients] on [Subsys] for four months, they’re hooked,” Burlakoff told Neely’s training group. “Then they’ll be on it for a year, maybe longer.”

(Privately Neely would ask him if by “hooked” he meant addicted. In reply, Burlakoff gave him a puzzled smile and would only say, by way if clarification, “It’s not addicted if [the patient] is in pain.”)

Like many sales managers, Burlakoff used pop cultural references to drive home his goals. In an early 2014 sales meeting that Neely attended, Burlakoff told a group of several sales reps that if they hadn’t seen the then newly released movie “The Wolf of Wall Street,” they needed to see it right away.

Burlakoff said, according to Neely, “It’s the best sales training video in history” (although carrying out its lessons could result in federal prison sentences.)

Another video that Burlakoff found inspiring was something he showed Neely toward the end of his training week. In a break after a session, Neely was pulled aside and shown a video of a man using a dildo to pleasure a woman. After the smartphone-shot clip ended, Neely found himself speechless.

“Alec,” he said, “what’s that about?”

To which, Neely said, Burlakoff only smiled and walked away.

Burlakoff had a very specific vision about the people he wanted at Insys.

For instance, Burlakoff rejected the framework of hiring and training practices of what he derisively called “Big Pharma.” He preferred to hire salespeople who were used to the pressure of having to make quota or face dismissal; prestigious colleges weren’t very important for that skill set. A sales rep who needed to get three prescriptions written in four days (or else) would push Subsys without dwelling on too many other things.

Because all that Burlakoff valued was sales — generating prescriptions — he made rather unusual hiring choices.

In April, for instance, the Southern Investigative Reporting Foundation reported on his decision to hire Sunrise Lee and make her sales chief of the Midwest region. They had known each other when Lee worked as a stripper in Miami and apparent escort agency owner. Lee’s Insys job centered largely 0n socializing with prescribers. Burlakoff described Lee’s professional skill in serving as “more of a ‘closer.'”

Burlakoff hired numerous women for key sales roles. As is the case at many pharmaceutical companies, the women were uniformly attractive and several had unique backgrounds. There was Amanda Corey Emhof, a former reality-TV show star who had won $477 on an episode of “Judge Judy” and had once considered becoming a sex therapist.

Prior to selling Fentanyl, Emhof posed for Playboy [NSFW]. She co-founded Thrive Model Management, a business that provided models for marketing campaigns and private parties where she heads “model managing.” Reached on her cell phone the day before Thanksgiving, she declined to comment.

Insys’ apparent practices of hiring women based on their looks, with extraordinary economic incentives to sell the drug, resulted in a good deal of extracurricular sales rep-doctor relationships complicated by sex. None more so than in 2013 when the wife of a high-volume Subsys prescriber found a revealing photograph of an Insys sales executive on his phone. Since she lived not far from headquarters, she drove there and raised a ruckus; she was assured that all appropriate measures would be taken against the rep.

The sales rep was promoted soon after to sales trainer; the doctor no longer prescribes much Subsys.

While Burlakoff’s laissez faire sales approach led to a great deal of revenue, some take issue with its practices. Dr. Ken Bradley, a Torrance, California-based pain management physician, said that he disagreed with Insys’ sales approach.

“Not a lot of doctors are going to write a [prescription for a drug] whose rep doesn’t understand it very much and dangling speaker programs in front of them doesn’t make up for that,” Bradley said, referring briefly to a sales rep he had dealt with who had worked in auto leasing before joining Insys.

Bradley added that he had, upon joining a practice, “inherited several patients” using Subsys but that after their course of treatment was completed, he declined to further prescribe the drug. (To be fair, he said the drug worked as it was supposed to.)

“The high-pressure sales tactics became annoying and were just another reason to not deal with [Insys’] sales staff,” he said.

Dr. Bart Gatz, a Boynton Beach, Florida-based pain-management doctor with multiple offices, said that the regulatory and insurance headaches associated with prescribing Subsys have “made it impossible to prescribe.” He added that he didn’t think he had written five prescriptions for the drug this year.

Coming from him, that’s devastating news for Insys: Gatz was the sixth leading prescriber of Subsys under Medicare in 2013 and was Insys’ fourth highest recipient of speakers program fees in 2013 and 2014, collecting more than $154,000.

“I’ve seen this a few times before where a company just grows too fast and does stupid things, gets some doctors to write inappropriately and the feds come down all over them and everybody else,” Gatz said. “That’s what happened here. It’s over.”

Gatz added that he liked Subsys and that it worked well for patients who couldn’t swallow or digest easily during chemotherapy regimens, but authorizing insurer payments had proved so difficult this year that he had switched his patients off the drug.

Asked about his Insys sales representative, Gatz mentioned that “she hadn’t been coming around very much” since he stopped writing prescriptions for Subsys. He said that it was difficult beginning a dialogue with her about Fentanyl products given that her previous job had been working as a cashier at a Publix supermarket.


Everyone named in this story was contacted for comment by phone, email and, if possible, text message — often multiple times.

Except where noted, no replies were received.

In all cases detailed messages were left about the nature of the Southern Investigative Reporting Foundation’s inquiry.

Insys Therapeutics, despite its profitability and current high profile, is unique in that it doesn’t have either an internal media relations staff nor an external advisor.

Calls seeking comment were directed to chief financial officer Darryl Baker, who did not return a call and text message sent to his cell phone.

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Murder Incorporated: Insys Therapeutics, Part I

Insys Therapeutics is a company in a great deal of trouble.

The manufacturer of a Fentanyl spray called Subsys with 100 times the strength of morphine, Chandler, Arizona-based Insys scored the top-performing initial public offering of 2013, according to CNBC. Analysts and investors adored the company’s fast sales and profit growth and dreamed of a future when Insys’ cash flow would lead to dividends and acquisitions.

As Insys’ market capitalization topped $3 billion, those who got in on the ground floor, investing early on, shared in its success: Founder Dr. John Kapoor became a billionaire and a host of company insiders, led by CEO Michael Babich, became millionaires.

Their joy was not to last.

Starting late last year critical press reports detailed alleged business practices at Insys so aggressive as to make the company an outlier in the oft-sanctioned pharmaceutical industry.

It wasn’t long before subpoenas began to pile up, with state and federal prosecutors on both coasts swinging into action; the U.S. attorney’s office in Boston, for example, impaneled a grand jury (and grand juries rarely fail to return indictments). Indictments of Insys’ most frequent prescribers continued and key executives have departed without notice.

Then came the lawyers.

In August, Oregon’s Department of Justice arrived at a $1.1 million settlement with Insys that represented about twice the amount of its revenue in that state. (In April, the company had settled a class action for $6.125 million.)

The proposed resolution from the Oregon Department of Justice makes for stark reading; it uses depositions and emails to claim that the company misrepresented a key scientific study, encouraged off-label prescriptions (allegedly in violation of U.S. Food and Drug Administration guidelines) and ran its speakers program solely to reward frequent prescribers.

While Insys’ investors haven’t thrown in the towel (the company’s share price has risen a split-adjusted 50 percent in the past year, in some measure because Kapoor and his family’s trusts control 66 percent of the outstanding shares), investor enthusiasm is starting to wane.

On Nov. 2, on the eve of an earnings announcement, CEO Babich suddenly resigned — a move that typically raises a major red flag for investors. Kapoor, who assumed the CEO mantle, told those listening on the conference call, “Mike decided that now is the best time to turn the page and focus on his family as well as pursue new opportunities.”

There’s more to the story, though.

Babich was forced out by Kapoor, according to a senior Insys executive who was in regular contact with Kapoor in the days prior to the announcement. While both men are the subjects of intense regulatory scrutiny, the founder and chairman bluntly told his lieutenant of 14 years that Babich was closest to the issues that federal prosecutors were looking at and that a change had to be made should settlement talks became serious, according to the executive source.

While Babich may be spending time with his young family, his personal life is more complex.

Earlier this year, Babich began a relationship with Natalie Levine, then a Boston area Insys sales executive who subsequently became pregnant; they married in the summer. (This is Babich’s second romance with a sales colleague; Kapoor has also dated two sales executives.) Aside from the fact that it’s unusual for a public company CEO to date someone who reports to him, the Babich-Levine relationship had another dynamic to it.

The newlyweds will probably be monitoring the developments in a rapidly expanding criminal suit filed in the U.S. District Court in Hartford where Heather Alfonso, an advanced practice registered nurse who was a high-volume Subsys prescriber over the past two years, pleaded guilty to accepting $83,000 in kickbacks. Federal prosecutors, according to the transcript of the July plea hearing, allege that the kickbacks prompted her to write Subsys prescriptions worth $1.6 million.

What appears to have brought the federal prosecutors’ intense scrutiny of the divorced mother of four was the baldness of the scheme. According to her plea, Alfonso was paid $1,000 each time she attended an Insys speakers event, where she was supposed to discuss with other medical professionals her clinical experience of Subsys. In reality, however, no other prescribers were present, and prosecutors said the events amounted to nothing more than Insys-sponsored dinners and drinks for Alfonso and her co-workers.

Natalie Levine was one of the sales staffers who called on Alfonso, and Levine arranged and attended many of the 70 speakers program events. As CEO, Babich approved two years’ worth of budgeted payments to Alfonso.

(While courts have traditionally recognized spousal privilege and declined to compel a husband or wife to provide testimony about a spouse, the events in the Alfonso case occurred before Levine and Babich married.)

Alfonso is cooperating with the government, as might be expected for someone facing a possible sentence of 46 to 57 months in jail; her sentencing date has been pushed back twice, most recently for six months. In the plea hearing transcript, prosecutors offered a pretty big clue about where Alfonso’s cooperation might be taking the investigation. For example, several Medicare Part D beneficiaries were described by prosecutors as ready to testify that she diagnosed them with having issues other than breakthrough cancer pain (the primary condition Subsys is indicated to treat) yet insurers still authorized the prescriptions.

As described in the transcript, Insys’ prior-authorization unit changed Alfonso’s diagnoses to cancer. Absent the alleged changes, the prosecutor asserted, the insurers would have never paid for the prescriptions.

And as the Southern Investigative Reporting Foundation wrote in July, Medicare and commercial insurers appear to have approved reimbursement of prescriptions for Subsys at vastly higher rates than those of its rivals in the Fentanyl marketplace.

The prior-authorization unit was set up to assist patients with complex insurance paperwork. Its value proposition was simple: The patient signs a few forms and Insys handles the messy paperwork. Patients would get the medicine, prescribers wouldn’t have to scramble for an alternate medication and Insys would book thousands of dollars in revenue per prescription.

In reality what the prior-authorization unit did was take advantage of pharmacy-benefit manager inertia to work a type of bureaucratic alchemy, whereby a torrent of off-label Subsys prescriptions would be transformed into ones associated with medically urgent cancer diagnoses.

Unmistakably, the prior-authorization unit was the key piece in helping Insys double the size of the Fentanyl marketplace to more than $500 million in less than two years.

Lost in the cascade of prescriptions, however, is the human toll from peddling Subsys like a new piece of software or an improved detergent. Since the drug was launched in January 2012, the FDA’s Adverse Events Reporting System lists 203 deaths for which medical providers have fingered Subsys as the probable candidate for triggering an adverse reaction. Moreover, the pace of purported Subsys-related deaths has been accelerating, with the FDA’s disclosing 52 deaths in the second quarter of this year alone.

(This FDA data is not definitive: It relies on voluntary medical-provider reporting so the number of incidents may be undercounted. Additionally, most reports represent a medical professional’s assessment and do not present an official cause of death.)

These deaths have occurred amid a nationwide opioid abuse epidemic. According to the Centers for Disease Control, in 2013 (the most recent year for which data is available), 16,235 Americans died from prescription opioid overdose. Subsys is now the top-ranked “diversion drug of concern”or the most frequently stolen or fraudulently obtained, according to the Department of Health and Human Services’ Office of the Inspector General.

What follows below is a description of what happens to a company when rule bending is institutionalized and the pressure to make a sale has deadly repercussions.


Danielle Gardner worked in Insys’ prior-authorization unit for a year and feels terrible about it. She is convinced that the unit’s arranging for insurance company approvals for thousands of off-label Subsys prescriptions led to the addiction or death of a certain percentage of the patients involved.

Gardner, whose name is a pseudonym, would love to be told that she’s jumping to conclusions, that there’s no concrete proof of anything like that. But the plain fact of the matter is that she is almost certainly right.

For a portion of her professional life, Gardner woke up each day to perform a job with a singular goal: to do anything to make the employees who handled pharmacy benefits for insurers think that the people who had been prescribed Subsys had cancer when only 1 percent of them did.

She and her seven or so colleagues did that one thing very well and many people made a great deal of money.

Gardner began her odyssey at the prior-authorization unit after her application submitted via a job-hunting site led to an interview. During her visit to Insys’ office, she deemed its operations to be busy and serious. To her, Insys seemed to be a growing company whose only business, as she was told, was helping people beat cancer.

“I liked the idea of helping people with the paperwork, which can be the hardest part of health care, but mostly I needed a job and [$18 to $20] per hour and benefits” was very good for Phoenix, she said. Better still, there was the prospect of bonuses. A veteran of several doctor’s offices, Gardner was well versed in obtaining insurance company approvals but had never heard of employees in a prior-authorization unit receiving bonuses. The decision was “yes” or a “no” proposition. How money came into the equation baffled her.

But her co-workers swore they were receiving the bonuses.

The bonus wasn’t the only matter that Gardner had questions about, though. She didn’t know why Insys’ prior-authorization unit was located across the street from headquarters or why the lobby had no sign for the division. The unit had a different phone exchange and a separate email server.

But Gardner kept her mouth shut.

While her boss Liz Gurrieri who ran the prior-authorization unit could be friendly, she had made very clear to everyone that the best questions were about how to do the job better. Gurrieri had built the unit from the ground up in 2012 and was held in the highest esteem at headquarters. In just a few years, as the story around the cubicles went, Gurrieri’s stock options had helped her become wealthy enough to build a six-bedroom house.

So everyone in the unit did things Gurrieri’s way because the money was good.

After a brief training period, Gardner went to work. Each day Gurrieri handed out stacks with five patient charts to Gardner and her seven colleagues and they would dive right in to make calls.

Prior-authorization unit staffers had a very specific formula that governed their life. Individually they had to secure 25 Subsys approvals a week; during a Monday meeting, Gurrieri’s boss, Michael Gurry from the corporate office, would tell the prior-authorization team the “group gate,” or minimum number of total approvals expected for the week, usually at least 200.

Assuming that the minimum was met, for every additional approval Insys gave $7 to a “bonus pool.” For example, if the prior-authorization unit received 300 approvals, then the bonus pool was $700 per person.

Plus there were individual bonuses: After a prior-authorization staffer secured 35 approvals, Insys gave the employee a $50 bonus and $10 for each incremental approval. So if Gardner received 47 approvals for the week, she would earn an extra $170 bonus on top of the $700 pool-based bonus. (A team member who failed to hit 25 was not eligible for a bonus.)

In a good week, Gardner found she could arrange for as many as 55 approvals; others achieved even more. After taxes, she was bringing home $3,000 to $3,500 a paycheck.

All she had to do, of course, was to change in the charts the insurance codes for the diagnosis of back or joint pain, organ problems, work accidents, military trauma or menstrual cramps into cancer ones.

Until the subpoena from the Department of Health and Human Services’ Office of Inspector General arrived at the end of 2013, that proved to be easy for her.

Up to that point Gardner would reply yes to pharmacy benefit manager employees who asked if the patient had “breakthrough cancer pain,” Gardner said. Then it was a slam dunk. Very few insurers wanted to be accountable for denying a cancer patient pain medicine. No matter what else changed, confirming a cancer diagnosis remained a requirement for any patient whose doctor was prescribing him or her Subsys for the first time, Gardner said.

Everything had been scripted per instructions from Gurrieri, with each phone call beginning with an identification of the prior-authorization unit staffer as being “from Dr. ____’s office.”

No one argued with success as the prior-authorization unit’s approval rates ran as high as 80 percent or more. They were limited only by the number of prescriptions written.

Despite the sharply increasing volume of Subsys prescriptions by the start of 2014, few, if any, pharmacy benefit managers had linked the prior-authorization unit to Insys.

Then again, few details were overlooked in keeping the connection obscured.

Outgoing phone numbers were blocked to avoid showing up on a caller ID and staffers were under orders to never use the company’s name when speaking to anyone from an insurer or a pharmacy benefit manager; if pressed, they would only say that they “were working closely with Dr. ___’s office.” When providing a phone number for a return call was required, they gave out a toll-free 800 number that would be answered by a colleague named Shannon. She would quickly direct the caller to the prior-authorization staffer without fielding any questions.

After the arrival of the Health and Human Services subpoena, which Gurry assured the prior-authorization unit staff was just a routine federal inquiry that a certain number of pharmaceutical companies underwent every year, Gurrieri ordered a change of strategy, Gardner said.

Instead of answering yes to questions about breakthrough cancer pain, prior-authorization unit staffers were to answer, “yes, they have breakthrough pain,” which was both an affirmative answer but ambiguous enough to mean virtually anything. Plus, pharmacy benefit management call-center employees, some of whom were located overseas and with hourly or daily quotas for handling calls, might mishear one or two words and consider the question properly answered. (The prior authorization unit never discussed the fact that insurers may have been given a false impression, according to Gardner.)

Through the spring of 2014, approval rates remained impressive, but pharmacy benefit managers began to push back, sometimes demanding to speak with the physician about the diagnosis. If the pharmacy benefit manager called the prescriber, that was a big problem in and of itself as the prior-authorization unit was in no way “from” any doctor’s office.

Messy episodes sometimes occurred, Gardner said, with physicians angrily insisting that no one by the prior-authorization staffer’s name worked at their office and that the patient in question did not have cancer.

Gardner said there were rarely long-term issues with pharmacy benefit managers, who would usually accept the prior-authorization unit’s explanations of misread charts and human error as an explanation. Doctors, too, often accepted an apology from the sales rep or a district manager.

By mid-2014, the fortunes of prior-authorization staffers were changing. The subpoena that Michael Gurry had assured them was part of a standard procedure for pharmaceutical companies didn’t go away and another arrived after Labor Day.

Given the legal issues that several key Subsys prescribers were experiencing, Gurrieri ordered Gardner and her colleagues to begin phone conversations by referencing “calling on behalf of Dr. ______’s office.”

Even so, approval levels were dropping in the late summer of 2014 as pharmacy benefit managers began demanding more detailed answers about diagnoses for a Fentanyl prescription. The approval woes went unnoticed to the world, however, as a spike in newly hired sales reps kept the prescriptions rolling in.

To reverse the trend of a slowdown in number of approvals, Gurrieri developed what prior-authorization staffers called “the spiel,” a series of dialogues (to commit to memory), designed to address detailed questions about whether a patient had breakthrough pain and cancer.

When someone from a pharmacy benefit management office asked about a patient’s having breakthrough pain from cancer, the prior-authorization staffer would reply, “The physician has stated that Subsys is approved for treating breakthrough cancer pain so (he or she) is treating breakthrough pain.”

While this response was wrestled with, prior-authorization staffers, per their instructions, would invent conversation to suggest they were right inside the prescriber’s office — something along the lines of “You should see this guy. It’s a real sad case and the doctor is upset about it.”

Approval rates began to stabilize and even inch back up, yet some of the biggest insurers began to become strident in their refusal to approve Subsys. Gardner said she told Guerrieri this, who pulled her into her office and instructed her to change the insurance code on patients charts to 787.20 on the most difficult cases. That was the code for dysphagia, a condition of having difficulty swallowing that’s related to illness. This served to box in the pharmacy benefit manager because a denial of a Subsys prescription could run the risk of starving a patient. This technique worked every time to secure an approval.

In addition, Gardner was ordered to intentionally mix up insurance codes, to substitute in, say, 338.30, associated with cancer-related chronic pain, for 338.29, which is for general chronic pain not connected to cancer.

Shortly after that, though, in the autumn of 2014, Gardner began to suffer anxiety related to performing what she was certain constituted unethical behavior, she said. She left the company shortly afterward.

“I couldn’t take [the misrepresentation] anymore,” she said, adding that she was “traumatized by thoughts of getting arrested.”

Gardner told the Southern Investigative Reporting Foundation that she had cooperated “extensively” with federal law enforcement officials over the past year about the nature of her prior-authorization job at Insys but declined to say she was asked about.

Her description of events at Insys’ prior-authorization unit was corroborated by other Insys employees, including sales representatives and managers, who had frequent contact with the group, a physician who was familiar with its operations, another prior-authorization unit employee — and a description in the now-settled class action.


As is the case for all Southern Investigative Reporting Foundation articles, numerous attempts were made to reach all the people in this story and provide them with an opportunity to comment on what had been reported about them. In cases where an email address was unavailable, a detailed voice message was left with questions. Over the course of several months, five attempts were made to contact Michael Babich and Natalie Levine on their mobile phones by leaving detailed voice messages and sending texts. They did not respond.

A call to Insys was referred to the company’s chief financial officer, Darryl Baker, and a voice mail was left on his office phone. A later call was placed and a message was left on his mobile phone as well. He never responded.

Michael Gurry did not reply to a voice message left on his office phone.

Multiple attempts to seek comment from Elizabeth Gurrieri were made that included messages being left on her cell phone and texts. On the one occasion she answered, she declined to comment, citing time constraints.

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Valeant’s Eastern Front

Poland seems a most unlikely place for the next chapter of Valeant Pharmaceuticals’ saga to play out. Weighing in with about 3 percent of sales, the Polish operations are seemingly a modest contributor to Valeant’s fast-growing bottom line.

But Valeant’s Eastern European operations have recently been the source of a good deal of message board rumor, which in turn has prompted the company to quickly respond.

So the Southern Investigative Reporting Foundation set out to see whether Valeant’s units in Eastern Europe are as robust as their North American brethren. The foundation chose Poland to start with because it’s the third largest geographic segment and, along with Russia, a core component of the company’s emerging markets unit (which represented 25 percent of sales last year). Just as important, unlike Russia, Poland doesn’t have a rich civic tradition of killing investigative reporters or the people working with them.

There’s a lot more inventory in the corporate supply chain than meets the eye, and that’s rarely a good thing, at least in the long term. Moreover, this is occurring against the backdrop of a flat sales trend in Poland.

Given the complex Valeant Europe organizational chart, sussing this out wasn’t a walk in the park.

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On Nov. 10, Valeant’s chief executive officer, J. Michael Pearson, during a conference call, noted that Polish inventory levels were currently equivalent to four months’ worth of his company’s then average sales rate and were slated to be lowered. The call to discuss Valeant’s business came in the wake of its Philidor-driven controversies stories that the Southern Investigative Reporting Foundation’s readers will recall it was the first to report.

Translated from business speak, what Pearson meant is that Valeant’s Polish operations has sold four months’ worth of inventory to a series of distributors, who, in turn, will deliver the products to retailers. Most CEOs want to avoid having inventory levels spike in distribution channels because over time excess supply reduces demand, which in turn forces production cuts and ultimately lowers the price of the product. (See what Valeant said when the Southern Investigative Reporting Foundation asked it about Polish inventory issues.)

But the full picture is much more complicated than that.

In Poland, three of Valeant’s subsidiaries, ICN Polfa S.A., PF Jelfa and Valeant SP. Z O, account for 98 percent of its revenue. Of the three, Valeant SP is by far the largest, amounting to about 75 percent of the revenue. It’s not, as might be expected, a manufacturer but a wholesaler, buying drugs Valeant produces in Poland and elsewhere, and then selling it to other distributors.

While Valeant’s explosive revenue growth is what made the company so beloved of investors, that hasn’t made it to Poland yet. Through the third-quarter revenue from the three units, as measured by IMS Health data, was just under $187 million and on pace to slightly improve upon last year’s $270.3 million. In turn, 2014’s sales were off relative to $296.4 million in 2013.

According to filings, at the end of last year, the three subsidiaries had 95 days’ worth of sales in inventory on its balance sheet. (There’s not a hard and fast rule for determining how much inventory is too much, but when it’s just sitting on a balance sheet and not moving, it’s a safe bet that the higher the figure goes, the more management and investors should worry.)

Add that to the 120 days of sales that Valeant recently acknowledged having in the channel. That’s 215 days of Valeant’s production chain that hasn’t made it to the retail market. Since the end of 2013, IMS Health data shows Valeant’s inventory in the distribution channel increasing to four months’ worth of sales from under two months.

To answer the question of whether that’s standard or not, take a look at how much inventory other major pharmaceutical wholesalers keep on their balance sheet. The three companies below, Neuca, Pelion and Farmacol, control nearly 70 percent of the Polish wholesale pharmaceutical market:

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So Valeant in Poland is clearly moving inventory less rapidly than its peers and per above, has put additional product into the channel earlier this year given the increase to four months of sales. To be fair, the comparisons are not exact given that the other three companies are purely wholesalers and Valeant has manufacturing operations.

A spokeswoman for Valeant, Renee Soto of Sard, Verbinnen & Co., said Polish inventory levels as of yesterday were back to three months’ worth of sales.

The supply chain process in Poland for getting a drug to a pharmacy from the plant is fairly described as labyrinth. Evidence the first is an occasional fourth step in the supply chain process called pre-wholesale warehouses, which are owned by the wholesalers but aren’t tracked by IMS Health. This inventory essentially falls “off the grid” and it’s nearly impossible to see how much is in there or how long it stays.

Industry insiders in Poland say that pre-wholesale warehouses hold inventory from manufacturers and charge them between 1.2 percent to 2 percent of the value of the inventory per month as a fee.

Then there is Myslowice, a 138,000-square-foot warehouse located equidistant between Valeant’s two other facilities in Jelenia Gora (546,000 square feet) and Rzeszow (412,000 square feet). One cannot easily find the facility listed on the company’s website because it leases it from DHL, the giant shipping and logistics company whose Exel unit often leases properties to work with key clients.

A recently granted license allows it to operate as a pharmaceutical wholesaler but unlike the other two facilities its permit allows it to sell on consignment. While consignment sales are fully legal, from an accounting perspective they often raise earnings-quality questions. (Bausch & Lomb, then an independent company, was ensnared in a consignment sale scandal in the 1990s.)

Valeant says the facility is currently its main distribution hub for Poland and Eastern Europe and that it does a small amount — about $4 million — of consignment sales there for a hospital unit. Read its full response.

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The Curious Case of Mr. Pearson’s 502,996 Shares

On Valeant Pharmaceuticals’ conference call on Nov. 10, embattled chief executive J. Michael Pearson offered several defenses of his company’s internal controls and procedures.

Similarly, in defending both himself and Valeant from the now constant drumbeat of controversy, one of Pearson’s constant refrains has emphasized his commitment to transparency.

A March 11, 2014, Securities and Exchange Commission filing suggests Pearson and Valeant have a long way to go on both of these fronts. Put bluntly, a footnote in a Valeant filing more than 18 months old appears to show how Pearson made a handsome profit through what is referred to as an unspecified “error.”

How handsome? Thanks to a rocketing stock price and corporate opacity, Pearson picked up a block of stock for $20 million less than it was then worth.

(Southern Investigative Reporting Foundation readers will recall its Oct. 19 revelation of the company’s secretive relationship with Philidor, its captive — and soon-to-be shuttered — specialty pharmacy that kicked off this trauma for Valeant. On Oct. 25 a follow-up story was released.)

Let’s start with why this is a truly unusual document for a Form 4, an often ignored class of company filings that disclose corporate insider share purchases and sales. Traditionally, the value of Form 4’s are usually interpreted in connection to a broader context or event, like executives selling into a potential corporate share repurchase or their buying shares because of an improving sales outlook.

In this case, given the unusually heavy weighting Pearson’s compensation plan has toward share price appreciation, a March 2014 Form 4 filing noting his acquisition of 502,996 restricted stock units — shares awarded only when share price appreciation triggers are met — was to be expected given Valeant’s then soaring stock price.

But then take a look at the filing’s footnote No. 2: “On May 24, 2013, the Registrant delivered 502,996 vested performance share units (the ‘2010 PSU Grant’) to Mr. Pearson in error. In connection with Mr. Pearson returning to the Registrant the value of such shares on the date of delivery (plus interest), Mr. Pearson has been credited with 502,996 vested share units to be delivered to him in accordance with the terms of the original 2010 PSU Grant.”

The awarding of 502,996 shares to Pearson “in error” is difficult to imagine for anyone who understands the compartmentalization of a large company.

Valeant is a large, fully-staffed corporation and Pearson’s compensation is closely scrutinized by both its board of directors and lawyers. As such, any clerical error would likely have been immediately caught.

Notwithstanding the error, there is no filing detailing the initial grant. The only mention  of the block prior to March 2014 is found buried in a footnote on page 32 of Valeant’s 2013 Proxy noting that the 502,996 RSUs had met their vesting triggers. Previous RSU grants, especially one for 486,114 shares in 2011, don’t seem to have generated any problems.

What we can say is that this is the kind of mistake that happens all too rarely in the professional lives of most people. On May 24, 2013, the date of the initial–and errant–restricted unit award Valeant’s share price was $84.47; on March 11, 2014, the stock closed at $139.96, a difference of $55.49. According to the footnote, Pearson appears to have rectified the error by writing a check for the “value of such shares on the date of delivery.”

The footnote’s language suggests that “the date of delivery” is May 24, 2013, meaning that sometime before March 13, 2014 — the date of the Form 4’s filing with the SEC –Pearson wrote a check for about $42.48 million (plus an unspecified interest rate) to own a block of Valeant shares that was then worth over $70.39 million, a nearly $28 million differential.

It’s not clear if these shares were part of the block of 1.3 million shares (out of 2 million originally) that Pearson had pledged to Goldman Sachs for a $100 million personal loan. The shares were seized by Goldman last week when he was unable to make an October 30 margin call.

The Southern Investigative Reporting Foundation requested comment from Valeant through Renee Soto at Sard Verbinnen, its outside public relations adviser. She said the company would not comment beyond its previously made disclosures. A follow up phone call was not returned.

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The Pawn Isolated: Valeant, Philidor and the Annals of Fraud

The Southern Investigative Reporting Foundation’s story looking at Valeant Pharmaceuticals’ well-concealed relationship with Philidor Rx Services, struck a nerve.

Briefly, the story explored the ways in which Philidor, a specialty pharmacy whose sole customer is Valeant, used opacity and some misdirection to try and build a national pharmacy network. Additionally, the Southern Investigative Reporting Foundation uncovered how Valeant had sought to conceal its control of Philidor.

A Valeant conference call scheduled for Monday morning, Oct. 26 is designed to explain these previously hidden relationships and, more importantly, calm the very frayed nerves of its battered shareholders.

But recently uncovered documents from a litigation between Philidor and R&O Pharmacy are probably going to have the opposite effect, in that they illuminate what can only be described as a bizarre effort to circumvent California regulations. Moreover, R&O’s allegations have been known to Valeant management for a month.

Additional Southern Investigative Reporting Foundation reporting has revealed that Valeant has been closely involved with Philidor at every stage of its life cycle, controlling it in all but name, since day one.

This pain isn’t being borne for no reason, however.  The foundation’s reporting indicates that Philidor is almost certainly one of the most important parts of Valeant’s business.


On July 21 Russell Reitz, a 64-year-old pharmacist and the “R” in R & O Pharmacy, was working in his office when a visitor dropped in unannounced. It was Eric Rice, an executive with Isolani, the company that had struck, what he thought, was a deal to buy the small compounding pharmacy back in December.

Rice had flown in from Philadelphia with several of the ranking executives of Philidor Rx Services. This Reitz found odd since when he questioned Rice about it, he insisted he worked for Isolani.

It was a tense but professional meeting and both sides left it unfulfilled.

Eric Rice was unable to come to an agreement over securing $3 million in payments he felt were due his enterprise. Reitz, for his part, had a startlingly basic question that Rice had not satisfactorily answered, both in a series of emails, and in person.

Reitz wanted to clear up once and for all, why despite his insistence that he worked for Isolani, he was always professionally connected to someone from Philidor. What was the difference between the two companies, or were they one and the same?

Rice’s colleagues, Philidor CEO Andy Davenport, general counsel Gretchen Wisehart and controller Jamie Fleming, were to Reitz’s eyes, in the middle of everything Isolani did.

Rice, whose LinkedIn profile left little doubt about where he worked, still couldn’t answer to Reitz’s satisfaction why, if he had agreed to sell his company to Isolani LLC, was Philidor the entity he always had to deal with? And what was Philidor’s real agenda anyway?

Moreover, neither Rice nor his colleagues, whose emails to him were getting increasingly strident, had ever answered another question Reitz had posed: Where was Isolani’s pharmacy permit? That they obtain their own, and not rely on R&O’s was a core component of the sale agreement. (It does not appear they ever applied for one.)

To Reitz, the huge volume of Philidor’s prescription drug sales, using R&O’s National Council for Prescription Drug Programs number, was infuriating; that a good deal of the millions of dollars in volume were in states where R&O had no registration to operate in, with drugs he never had dispensed, and filled by a pharmacy he did not own, was nauseating. To pile insult upon injury, he had refused to sign the pharmacy’s audit only to learn it was signed by Eric Rice.

This dispute had transcended the “he said-she said” realm of most business disputes a few weeks prior and was something Reitz hadn’t supposed existed apart from movies featuring the mafia taking over a business. Apart from Ray Liotta and Joe Pesci’s absence from this drama, it was in every sense a bust out.

Not that there weren’t signs that R&O was more to Isolani than just a platform for compound pharmaceutical sales. Back in mid-December, shortly after the deal was inked, Reitz was surprised to see Jamie Fleming, Isolani’s controller, show up at his office with boxes of inventory. He had a man with him who introduced himself as Gary Tanner, and who was clearly in charge. It all seemed on the up and up, if a bit sudden.

After meeting Tanner, Reitz went back and looked him up. He couldn’t understand what Gary Tanner, a specialty pharmacy expert with Valeant’s Medicis Pharmaceuticals unit was doing involved with R&O. In July, Tanner’s signing of an employment contract was something the company would later find it important enough to disclose to investors.

Reitz couldn’t have possibly known that a few months prior to approaching R&O, Philidor executive Sheri Leon had signed a California State Board of Pharmacy Change of Permit request for West Wilshire Pharmacy, despite providing inaccurate answers to standard questions. Under oath, she answered “no” to questions asking if she had ever worked for an entity that had been denied a California permit, and if any other entity owned more than 10 percent of her company.

That May, Philidor had been denied a nonresident pharmacy permit and like Isolani, it controlled Lucena Holding LLC, the entity used to buy West Wilshire Pharmacy.

On Jan. 7 Eric Rice would sign a similar document seeking transfer of R&O’s license to Isolani.

Something Reitz might have looked into, was the origin of the word Isolani. It comes from the world of chess. To simplify a complex theory, it centers around isolating the pawn, the weakest and least consequential figure in the game.

Given Reitz’s refusal to pay, Isolani sued him in September to obtain a judicial order to preserve what it alleged was at least $15 million out of a total of $19.3 million worth of checks written to it. In response, his lawyer Gary Jay Kaufman filed a 68-page declaration. The next court date is set for the middle of December.


What Gary Tanner was doing at R&O was his job, which includes being the overseer, for want of a better term, of Philidor and its network of affiliated (or captive) pharmacies.  Tanner’s exact title is unclear but an ex-Medicis executive said that he is Valeant chief executive Michael Pearson’s primary contact about Philidor’s operations.

This source said that Tanner has often worked in conjunction with a lawyer, Michael Dean Griffen, and another (now apparently former) Medicis employee, Bill Pickron, to source these types of pharmacy transactions for Medicis and Valeant.

The Southern Investigative Reporting Foundation’s reporting suggests that there is little to separate Valeant and Philidor beyond corporate wordsmithing. Indeed, former Philidor employees said Valeant’s executives were such a constant presence at the Hatboro, Pennsylvania, headquarters facility, that it was commonly supposed they had a block of rooms permanently reserved at local hotels.

Consider Philidor’s launch in June 2013. It’s a safe bet that Valeant heavily underwrote or otherwise subsidized the company given the long lead times of insurance reimbursement, coupled with the stress on working capital of starting a business with rapid expansion plans.

According to former employees, Philidor places heavy productivity demands on its call-center and data-entry personnel, but pays them decently: SIRF found most employees earned between $20 to $25 per hour, but in return a near 60-hour week was mandatory.

This is where the stress on working capital management factors in, since overtime would add at least $400 extra per employee paycheck. On top of that, from a late 2013 headcount of 250, Philidor added an average of 100 employees per quarter, as well as a 28,000-square-foot lease, utilities, health care, insurance and the frequent “extras,” like free lunches and coffee, to incentivize employees to stay at their workstations.

Eventually, of course, the reimbursements for the thousands of prescriptions roll in, but until then those bills have to be paid. Nothing about the economic profiles of Philidor’s management group suggests they have the ability to personally absorb the millions of dollars it cost each month to get the company off the ground.

For example, Philidor chief executive Andy Davenport, while the owner of a five bedroom, 3,500-square-foot house in nearby Horsham, has had a series of municipal liens placed against him for unpaid county and state property taxes.


At bottom, pharmacies like R&O were a way for Philidor to surmount the very big hurdle resulting from the California Board of Pharmacy rejection, in May 2014.

(It is quite a read, referring to several “false statements of fact” by Matthew Davenport –the CEO’s brother — including the nondisclosure of Philidor’s true owners and their real equity stakes.)

The headache existed because, as ex-Philidor employee Taylor Geohagan put it when interviewed last week, “Billing from a [pharmacy’s] license in one state, but shipping from a California location, is against the rules.”

He would add, “Pretty much everything we did in the [Philidor] Ajudication department was use the [National Provider Identifier] codes from the pharmacies we bought out to get something [approved] in a pinch.”  He described his Philidor experience in a website posting at that said that paper copies of the NPI numbers of “sister pharmacies” were rarely handed out, and if they were, they were soon taken away and shredded.

Geohagan said that when he left the company in late summer, the practice of using multiple NPI numbers had stopped. (At least part of his animus toward the company, he wrote, resulted from resigning with two weeks of notice and being fired the next day.)

The Philidor billing department manual actually has a page that discusses using the NPIs of these so-called captive pharmacies called “Our Back Door Approaches,” according to another former employee. For example, when attempting to secure approval for a prescription with an insurance company Philidor did not have a relationship with, employees were instructed to use West Wilshire’s NPI.

Two ex-Philidor employees from the adjudication and billing departments told the Southern Investigative Reporting Foundation that the volume of prescriptions flowing into the company was massive, with billing unit workers expected to process at least 100 prescriptions daily. The former adjudication unit employee showed the Southern Investigative Reporting Foundation internal documents from November trumpeting the fact that 22,299 prescriptions were filled in the prior week. Additional documents showed other weeks that came in above 23,000.


A strategic distancing from the controversial unit does not appear to be an option for Valeant.

The Isolani v. Reitz litigation reveals that Philidor’s use of these captive pharmacies is a vital revenue stream for Valeant. Some digging around in its corporate filings shows that R&O, at least before Russell Reitz began to object in July, was poised to a material contributor to organic growth.

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A brief aside: organic growth, or the increase in sales apart from Valeant’s acquisitions of other companies, is vital to the debate over its future. Short sellers and other critics, for example, have argued that the company’s drug brands are, in the main, declining; without the torrid pace of acquisitions, shrinking revenues and profits are a foregone conclusion.

Thus the importance of looking at what Philidor’s newly exposed captive pharmaceutical network reveals. Here’s what it shows: In the second quarter, Valeant’s 8-K reported “organic” sales growth of 19 percent, with revenue growing $691 million, to $2.73 billion from $2.04 billion.

Of this $691 million, however, at least $392 million was attributable to acquisitions, with the $299 million balance organic revenue.

The Kaufman declaration’s release of the Philidor/Valeant invoices to R&O imply a prospective quarterly sales run rate of about $55 million (an average $4.6 million weekly shipment multiplied by 12 weeks). This would have accounted for 18.5 percent of Valeant’s total organic growth in the second quarter. From there, it’s a sure bet that given the prominence of West Wilshire to Philidor’s billing unit, its sales volume would easily surpass R&O.

Notionally, organic growth equal to 40 percent or more of that $299 million could have come from two pharmacies that even the most gimlet-eyed Valeant sleuth didn’t suspect existed.

It also becomes much easier to understand why Valeant’s management didn’t immediately sever the relationship with Philidor.


An outside spokeswoman for Valeant, Renee Soto of Sard Verbinen, told the Southern Investigative Reporting Foundation last week the company would not comment.

A message left for Gary Tanner was not returned.

And attempts to contact Eric Rice and other Philidor employees named in the story by placing calls to the company’s management ended up with their being routed to Greg Blaszczynski, the chief financial officer of BQ6 Media. That’s the pharmaceutical marketing effort where both Davenport brothers have served as CEO.

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The King’s Gambit: Valeant’s Big Secret

If the name Valeant Pharmaceuticals International doesn’t ring a bell, its business practices should. The Quebec-based drug manufacturer’s policy of implementing regular price increases that often run north of 100 percent has generated plenty of anger, a congressional investigation, constant press coverage and a subpoena from the U.S. attorneys’ offices in both the Southern District of New York and the District of Massachusetts.

But as strange as it may seem, a slim legal filing in California federal court is poised to make Valeant’s world rockier still.

The story starts 50 miles northwest of Los Angeles in Camarillo, California, with R&O Pharmacy, a modestly sized operation co-owned by veteran compounding pharmacists Russell Reitz and Robert Osbakken.

According to a lawsuit filed by R&O, Russell Reitz received a letter from Robert Chai-Onn, Valeant’s general counsel and director of business development, requesting repayment of $69.8 million for “invoiced amounts.” This apparently struck Reitz as odd since R&O had done no business, at least in any direct fashion, with Valeant. Moreover, he had never received a single invoice from Valeant or its subsidiaries.

Reitz forwarded the letter to Gary Jay Kaufman, his lawyer in Los Angeles, who sent a letter to Chai-Onn on Sept. 8, noting that the lack of invoices from Valeant indicated to him that one of two things was happening: Valeant and R&O were being jointly defrauded by someone, or Valeant was defrauding R&O. He suggested they talk it over by phone.

Chai-Onn never responded, and on Oct. 6 Kaufman filed suit, seeking a determination from the court that R&O owes Valeant nothing.

There is, however, a hook, and as these things go, it’s a big one: The Southern Investigative Reporting Foundation has confirmed that Reitz was indeed doing business of some sort through a company called Philidor Rx Services and a man named Andrew Davenport.

Which makes Valeant’s demand letter very interesting.

To understand why, it’s important to understand what Philidor is. To the public, it describes itself as a “pharmacy administrator” and, according to a call service operator last Thursday, Valeant is its only client. Located in Hatboro, Pennsylvania, about 30 miles outside Philadelphia, Philidor noted in its corporate filings that both companies are independent of each other.

The phrase “pharmacy administrator” appears to be, in Philidor’s case, a term of art.

A better description is a “specialty pharmacy,” that fills, ships and obtains insurance approval for prescriptions of the more complex drugs Valeant makes. During its third-quarter conference call last year, the only instance when Philidor has been publicly mentioned by an analyst, Valeant chief executive Mike Pearson said that perhaps 40 percent of its business flows through specialty pharmacies. In July he reiterated the company’s guidance for up to $11.1 billion in 2015 revenue, suggesting that as much as $4.4 billion in product could move through this Philidor channel.

(Note that specialty pharmacies are exempt from reporting the drugs they sell to IMS Health, the tracking service used by companies and analysts to monitor drug sales and inventory channels.)

As is the case with many private companies, the financials of Philidor are hard to come by, but it is unmistakably an operation of some mass, with about 900 employees and its own legal unit. A Pennsylvania state senator posted an April 6 interview with company CEO Andy Davenport in which he stated the company was on track to process 12,000 to 15,000 prescriptions daily by December. With prescription costs regularly running into the hundreds and even thousands of dollars, the company could potentially handle upward of $1.5 billion in product this year.

Here’s a key cog in Valeant’s “patient access” program: Patients referred to Philidor often receive coupons for reduced or waived co-pay requirements (given to the prescriber by Valeant’s sales representatives). And, in turn, Philidor would appear to attempt to recoup the cost of the drug from private insurers or Medicare. Theoretically, this makes price increases less risky for Valeant, given that a sizable population of a drug’s users frequently don’t have the capability to observe them. Still, the patient access program is central to the company’s distribution program, and one of the issues the U.S. attorneys’ subpoenas specifically sought information about.

Philidor’s business practices have generated mixed reviews (at best) on consumer message boards — including numerous instances of alleged unwanted refills and an allegation of the improper removal of HSA funds. Another message board account alleges that to get reimbursement approvals, prescriptions already denied at larger insurers were “pushed through” their sister pharmacies. (To be sure, comments on these sites can be gamed, both by consumers and the company, and the Southern Investigative Reporting Foundation was unable to verify these accounts.)

Several questions remain unanswered: On the assumption that there is $69.8 million due someone, why wouldn’t Philidor’s two in-house attorneys have issued a demand letter to R&O? Similarly, why wouldn’t Valeant’s high-profile general counsel, when challenged, not provide support for his demand and avoid the risk and expense of litigation? Additionally, if Valeant does have some sort of claim to that nearly $70 million, what then is their real relationship to Philidor?


The Southern Investigative Reporting Foundation was able to uncover Valeant’s financial connection to Philidor — one that it hasn’t disclosed to investors — as laid out below.

The first task was to establish who owns Philidor. What we discovered was indeed revealing, albeit probably not in the way its owners intended.

Put bluntly, Philidor has gone to great lengths to conceal its ownership. Start with a man named Matthew Davenport, the listed principal on most of Philidor’s state registrations; additionally, several states list David Wing, John Carne and Gregory Blaszczynski as officers, and a few more have an End Game Partnership LLP listed as an assistant treasurer.

Given Andy Davenport’s video above, his role as Philidor’s chief executive is clear. Plugging the address of End Game Partnership LLP (which in turn is owned by End Game LLC, a Las Vegas-based entity) from its filings into a search engine turns up a match to a house Andy Davenport owns in Horsham.

A Southern Investigative Reporting Foundation phone call to Philidor’s administration revealed that there is no Matthew Davenport, David Wing, (Edward) John Carne or Gregory Blaszczynski working at Philidor. On the other hand, all four work at BQ6 Media, a pharmaceutical marketing company located about 2.5 miles from the company. At one point, prior to Philidor, Andy Davenport was its CEO. Both BQ6 and Philidor share the same domain registrar, Perfect Privacy LLC. The company’s LinkedIn profile lists 28 employees but the majority are consultants or contract workers, with several listing time spent at Philidor.

The Philidor state registration in North Carolina was particularly helpful in that it listed a broader array of owners than other states.

David Cowen is a former hedge fund manager and Elizabeth Kardos is general counsel for restructuring consultants Zolfo Cooper who are married and own Four Beads LLC; they did not return a message left at their house or reply to an email sent to Kardos. Nick Spuhler is a BQ6 alum who could not be reached, David Ostrow is a physical therapist and golf swing coach who did not return multiple calls to his house and residence, Jeffrey Gottesman is an insurance agent who has a sideline as a competitive poker player; reached on his mobile phone, he declined comment. The address listed for Gina Miller tracked to a code inspection business with no apparent connection to Philidor. Alternatively, a Gina Milner works at BQ6, but it couldn’t be determined if she is involved. Fabien Forrester-Charles of Hatboro, Philadelphia, and Francis Jennings of Naples, Florida, could not be reached, and Michael Ostrow of Bala Cynwyd, Philadelphia, did not return a voice message left at his house. Paula Schuler of Old Greenwich, Connecticut, listed as an owner along with her husband Timothy, said she couldn’t talk at that moment; she never returned two follow-up calls.

It is not readily apparent if there are any specific relationships among group members, beyond the general ties to Matthew and Andy Davenport (according to an online database they appear to be brothers), BQ6 and Philadelphia. One that does jump out is David Cowen and Andy Davenport’s tenure together at hedge fund Quasar Financial between 2004 and 2008; Davenport also donated to the Museum of American Finance, where Cowen is the president.

Not every state looked kindly upon the way Philidor went about securing out-of-state pharmacy operation privileges. California took exception to Matthew Davenport’s attempt to register as Philidor’s principal and rejected the company’s application for a Non-Residency Pharmacy Permit in May 2014. The state’s Department of Consumer Affairs Board of Pharmacy cited a series of disclosure-related problems, specifically his swearing to what was termed “false statement of facts” on the application, several of which involved the failure to disclose Philidor’s ownership group, as well as Andrew’s 27 percent ownership stake.

(A brief aside: Francois-Andre Philidor was an 18th-century French chess master, who wrote a book about it, “The Analysis of Chess.” BQ6 Media is named after the chess shorthand for Bobby Fisher’s legendary move against Russian chess master Boris Spassky in 1972. Another popular chess move is the King’s Gambit Accepted, or as it’s often referred to in chess notation, KGA.)

Establishing the economic connection between Valeant and Philidor was less time-consuming.

As it happens, Valeant has a wholly owned unit named KGA Fulfillment Services Inc., that was formed in Delaware in November 2014. Its only mention in any Valeant filings is that sole line in last year’s annual report. An exhaustive search didn’t turn up any references to it in trade publications, nor state and federal databases. (What the initials stand for, apart from the similarity to the chess strategy, is unknown.)

The Southern Investigative Reporting Foundation found KGA Fulfillment Services listed  as the “secured party” on UCC-1 liens placed this January and February against the members of Philidor’s ownership group. These liens are the public notice that a lending entity may have an interest in the debtor’s personal property. In this case, Valeant/KGA lent money to Philidor’s ownership group, and per the rules is announcing that their equity stakes in Philidor are potentially collateral.

The UCC-1 financing statements for the group are David Cowen and Elizabeth Kardos, Timothy and Paula Schuler, Nick Spuhler, Andrew Davenport Trust, David Ostrow, David Wing, John Carne, Matthew Davenport, Fabien Forrester-Charles, End Game Partnership LLP, End Game LP and Michael Ostrow.

That an important financial relationship exists between Philidor and Valeant’s KGA unit is inarguable; why it exists is much less clear. From the standpoint of rational self-interest, the owner of a rapidly growing business would almost never want to borrow against their equity stake, let alone from the newly launched subsidiary of the enterprise’s sole customer.


Over several days, since coming across the California lawsuit, the Southern Investigative Reporting Foundation made repeated phone calls to every person or company discussed above. With the exception of Jeffrey Gottesman from the Philidor ownership group and R&O Pharmacy’s lawyer, Gary Jay Kaufman — who both declined to comment — every other person did not return our calls.

Robert Chai-Onn did not reply to a call to his office; a call to a mobile phone registered to his name was answered by his wife, who said she was on the West Coast and was unsure where her husband was at that moment.

Meghan Gavigan of Sard Verbinnen & Co., an outside spokeswoman for Valeant Pharmaceuticals, was unable to secure a response from the company.

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SIRF Wins Lawsuit and Strikes a Sharp Blow for Journalistic Freedom

The Southern Investigative Reporting Foundation has successfully concluded a litigation arising from its September 2014 story on Southern California-based medical device entrepreneur Anthony Nobles.

Readers may recall that the investigation centered on Nobles, a high-profile Ferrari collector whose elaborate Halloween parties are regularly profiled in the press — and whose affluence allowed him to own multiple homes, make large charitable donations and buy a $200,000 ticket on Virgin Galactic‘s first commercial space flight.

Reporting by the Southern Investigative Reporting Foundation revealed that Nobles claimed a series of graduate degrees that were likely purchased from a notorious online diploma mill whose founder pleaded guilty to issuing fake diplomas and will be sentenced in November, according to a recent Department of Justice filing.

Additionally, the Southern Investigative Reporting Foundation reported that Nobles’ previous efforts with publicly traded companies were mired in controversy and investor litigation.

On Oct. 1 Nobles filed suit against the Southern Investigative Reporting Foundation and the two authors of the article, summer intern Keith Larsen and me, alleging defamation and libel per se. In the two weeks between the release of the investigation and the filing of his claim, Nobles never sought any corrections.

Amusingly, to support a claim that I was a reckless reporter, Nobles’ attorney, John van Loben Sels, cited Deep Capture, a website backed by founder Patrick Byrne. The website published a series of articles whose premise is that a wide-ranging conspiracy of hedge fund managers, well-known business reporters and corrupt public officials actively worked together to prevent the commercial success of a prostate cancer drug for the benefit of disgraced 1980s junk bond financier Michael Milken, himself a prostate cancer survivor; I and board member Bethany McLean are portrayed as conspirators.

It wasn’t the most fertile soil for planting a flag: Deep Capture, and Byrne are defending themselves in a Vancouver, Canada-based defamation suit from Ali Nazerali, a Vancouver stock promoter who Mark Mitchell — the site’s primary reporter, as well as a defendant in the suit — had fingered as a key al-Qaida financier. In June, the defense rested without calling any witnesses. The trial resumes in September.

On Nov. 3, Nobles filed a temporary restraining order motion that sought to have the article taken down.

The Southern Investigative Reporting Foundation, through its lawyers at Brooks, Pierce in Raleigh, North Carolina, filed a response to the motion on Nov. 5 that argued that Nobles’ filings didn’t meet any of the criteria for granting an injunction. The court agreed and on Nov. 7 United States District Court Judge Louise Flanagan denied Nobles’ motion.

For the next several months both sides waged a battle of legal filings — such as this memorandum of law in opposition to Nobles’ claim — that culminated in Judge Flanagan’s May 8 order bluntly dismissing all of Nobles’ claims, granting the Southern Investigative Reporting Foundation what appeared to be a remarkably broad victory. On June 8, however, Nobles’ filed his notice of appeal seeking review by the U.S. Court of Appeals for the Fourth Circuit. In response, the Southern Investigative Reporting Foundation cross-appealed the trial court’s denial of its legal fees.

In late July Nobles’ lawyer reached out to the Southern Investigative Reporting Foundation to settle the matter and an agreement was reached: Nobles dropped his appeal and the Southern Investigative Reporting Foundation dropped its attempt to collect its fees. Somewhat anticlimactically, it was over, albeit thousands of dollars and a great deal of stress later.

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The Black World of Insys Therapeutics

Slowly but surely answers to the many riddles of how Insys Therapeutics could achieve its mercurial success are beginning to emerge.

The Scottsdale, Arizona-based pharmaceutical company has only one commercial offering, a sublingual Fentanyl formulation called Subsys, whose sales growth has managed to double its market’s size, to more than $500 million from an estimated $225 million since its approval and launch in March 2012, according to executives at rival companies. In turn, the upward march of the company’s share price has turned its growing legion of supportive brokerage analysts and money managers into minor geniuses. (Southern Investigative Reporting Foundation readers will recall Insys from an April 24 investigation of the drug’s mounting number of lethality cases and the company’s unusual marketing efforts.)

Therein lies the rub.

Subsys is approved only to treat breakthrough cancer pain. The market for such drugs was estimated to have an annual growth rate of about 10 percent in the spring of 2012, according to former Insys sales staff and rival pharmaceutical executives. Instead, on March 21, 2014, about two years after its launch, Subsys managed to nose past Cephalon’s Actiq, then a leader in this narrow category, in number of prescriptions written, according to IMS Health data obtained by SIRF; last September Subsys took the lead for good.

These opioid drugs are so potent that the Food and Drug Administration created a stringent prescription protocol for them (known as TIRF-REMS), with multiple steps for a patient to go through before a prescription is dispensed.

Yet according to Medicare Part D records for 2013, no oncologists appear on the list of Subsys’ biggest prescribers.

Given this apparent lack of support from oncologists, it appears odd that insurance companies seem to have embraced Subsys, continually approving its reimbursement at a level none of its competitors can obtain. A leading Subsys prescriber told the Southern Investigative Reporting Foundation that in his estimation, “Insurers cover over 90 percent of [Subsys prescriptions] for at least one [90-day] cycle,” whereas rival drugs appear to have an approval rate hovering at 33 percent. The doctor’s account of a chasm between how insurers treat Subsys and how they deal with its rivals was corroborated by a senior executive at an Insys rival and three former Insys sales staff members.

But it was not until records in the Centers for Medicare & Medicaid Services Open Payments database were released in October 2014 — covering the last five months of 2013 — that a linkage could be more readily detected between the volume of Subsys prescriptions and payments to doctors.

As Insys’ share price continued to trend upward, Wall Street’s brokerages found it easy to promote the company’s business practices, as a Jefferies research report from December shows.

But now federal prosecutors are peeling back the veil to reveal a black world behind Insys’ earnings. The initial results suggest they do not condone what they are seeing.


Dr. Gordon Freedman, a 55-year-old anesthesiologist, is in every way imaginable a member of New York’s medical establishment, with a busy two-office practice and, until very recently, a faculty appointment at the Mount Sinai School of Medicine.

A graduate of the Sackler School of Medicine, Dr. Freedman resides in Irvington, N.Y., a pretty village along the Hudson River just 20 miles north of Manhattan. This seems to be the perfect capstone to a life that outwardly evinces the virtues of taking initiative and pursuing hard work.

But in life, as in medicine, the mechanics of how the system works matter. And for Dr. Freedman, the road to success has been paved with lots of Insys’ cash.

The June 30 update to the Centers for Medicare & Medicaid Services Open Payments database included the full amounts of pharmaceutical company payments in 2013 and 2014 to doctors for entertainment and speaking at corporate events and for research. The database revealed that in the last two years Insys spent almost $204,000 on Dr. Freedman, with more than $147,000 of that being for speaking programs last year in 52 separate payments of $2,400 to $3,750, not including food and travel expenses; none of the money was for research.

Was paying Dr. Freedman so much a good investment for Insys? Probably — at least initially.

Medicare Part D records show that in 2013, the most recent year for which data is available, Dr. Freedman ranked as the 15th-highest Subsys prescriber as measured by dollar amount, having written 35 prescriptions that cost Medicare $393,961. The Southern Investigative Reporting Foundation, via a database tracking TIRF-REMS prescriptions, identified 60 Subsys prescriptions that Freedman wrote from March 2012 (when Insys obtained FDA approval to sell the drug) to the end of December 2013.

The math behind a typical prescription shows why Insys has not been hesitant to pay prescribers to talk about the drug. In 2013 the wholesale acquisition cost of a 90-day supply of Subsys of 400 micrograms, statistically the most frequently prescribed amount according to Wolters Kluwers data, cost $4,608. In 2014 at a blended cost of $58.68 per unit (there was a midyear price hike), that same 90-day supply cost $5,281. Currently, priced at $97.80 per unit, a prescription costs $8,802. (These figures do not take into account frequent discounts.)

The Southern Investigative Reporting Foundation repeatedly reached out to Dr. Freedman to discuss his speaking engagements but he did not return multiple calls to his home, office or cell phone; he also did not reply to an email sent to his Mount Sinai address.

In response to questions about the ethics of Dr. Freedman’s Insys payments, Mount Sinai spokeswoman Elizabeth Dowling emailed the following statement: “Dr. Freedman is not employed by Mount Sinai and we do not have access to the details of his personal relationships with non-Mount Sinai entities.” She did not reply to follow-up questions.

As the chart below indicates, Dr. Freedman was hardly alone in profiting from Insys’ gravy train; 12 other doctors received more than $100,000 last year from the company.

Medicare rank is determined by the value of Subsys prescriptions written by the doctors.
Medicare rank is determined by the value of Subsys prescriptions written by the doctors.


The nearly $7,390,872 that Insys spent last year on payments for what it calls “compensation for services other than consulting” —  with $6.3 million going to doctors and the almost $1.1 million balance for travel and entertainment costs — stands out from the practices of its competitors marketing TIRF-REMS drugs.  The $7 million sum represents 7.2 percent of Insys’ 2014 selling, general and administrative expenses, with the speaker payments amounting to 2.9 percent of its total sales.

In comparison, Galena BioPharma, the maker of Subsys competitor Abstral, spent just $132,372 on what it calls “honoraria,” representing 0.4 percent of selling, general and administrative expenses, with speaker payments amounting to 0.8 percent of total sales. (To be fair, Depomed, the maker of Lazanda, spent $206,250, or 3 percent, of its almost $7 million in sales on speakers.)

When the Southern Investigative Reporting Foundation interviewed Insys’ sales chief Alec Burlakoff in April, he bristled at the suggestion of a quid pro quo between prescription-writing volume and speakers program compensation. As he saw it, the speakers program was the pharmaceutical industry version of a university’s faculty lounge, where colleagues could discuss the latest approaches and innovations in their discipline (albeit one where the conversations are shaped by frequent payments of thousands of dollars, as opposed to a reinterpretation of Sylvia Plath).

“Putting board-certified doctors together, where one of them is explaining the benefits he or she is seeing” [from prescribing Subsys] was the key to the company’s remarkable sales growth, Burlakoff said.

But federal prosecutors have recently served notice that they are taking a very different view of Insys’ speakers program. In a pair of cases in Connecticut and Alabama, assistant U.S. attorneys have removed some of the basis for support of the company among brokerage and investors by definitively linking three of the most highest-volume Subsys prescribers to Insys’ payments of “bribes” and “kickbacks” in open court.


In Hartford’s U.S. District Court on June 23, nurse practitioner Heather Alfonso of Derby, Connecticut, pleaded guilty to accepting $83,000 in bribes from a pharmaceutical company that were designed to influence the choice and amount of prescriptions she wrote. According to an account of the proceeding, the company was identified as Insys and the payments were made under its speakers program.

Apart from the connection of the speakers program to bribery, Alfonso’s surrender of her prescription-writing licenses means Insys loses another important prescription writer, in the latest round of the cat-and-mouse type contest between law enforcement and the high-volume writers of Class II opioids prescriptions. She was the 22nd-highest Subsys prescriber in 2013, according to Medicare Part D data, and ranked 25th in Tricare records in 2014.

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Alfonso, in her plea, admitted to having been paid for her attendance at 70 separate speaker dinners, with the prosecutor describing them as either having no doctors or physician assistants in attendance — and thus no educational value — or as meals with only her Insys sales representative and friends in attendance.

The plea completes a remarkably tumultuous six-year span for Alfonso. In July 2009, with five children and her parents claimed as dependents, she sued for protection from creditors under Chapter 7 of the bankruptcy code, listing $424,682 in assets and $525,316 in liabilities.

According to Alfonso’s plea agreement, she is potentially facing 46 to 57 months in prison but the prosecutors reserve the right to request that a judge adjust that figure, presumably downward. None too subtly, this means that Alfonso has a remarkable incentive to negatively portray Insys and its sales practices.

Reading between the lines of the press release announcing Alfonso’s plea, however, an observer could infer that federal prosecutors are expanding the investigation beyond the bribery plea into insurance fraud.

“Interviews with several of Alfonso’s patients, who are Medicare Part D beneficiaries and who were prescribed the drug, revealed that most of them did not have cancer, but were taking the drug to treat their chronic pain,” according to the release. “Medicare and most private insurers will not pay for the drug unless the patient has an active cancer diagnosis and an explanation that the drug is needed to manage the patient’s cancer pain.”

To whit: Alfonso’s patients received Subsys despite the absence of a cancer diagnosis; without it, a refusal of coverage is nearly automatic within the field. Thus the granting of insurance reimbursement could imply that somehow the diagnosis codes of these patients were changed.

This also speaks to what the unnamed physician referenced above, about Subsys prescriptions’ being approved by major commercial insurance carriers and Medicare much more frequently than prescriptions of rival medications were.

On investor conference calls, Insys CEO Michael Babich has mentioned a dedicated prior authorization unit that works closely with a prescriber’s office and sales staff to assist with paperwork. But other rivals do this, too, and while Insys might realize more efficiencies, it seems unlikely that the company is almost three times better at this.

One possible answer is provided in a class action (recently settled for an undisclosed amount): A confidential witness from Insys’ prior authorization unit claimed that staff people were trained to impersonate prescriber office staff when talking to pharmacy benefit-management companies, lie about the previous drugs taken by the patient (most insurers require patients try a generic drug and have it fail before a branded drug is approved) and tailor diagnoses to insurers, based on internal records of prior approval rates.

Insys never responded to these charges prior to the class action’s settlement.

Another possible explanation lies with the remarkably close working relationship that Insys has with a drug distributor called Linden Care, based in Syosset, New York. Former sales executives describe this bond as much closer than the standard vendor-distributor relationship, such that any issue with a prescription could be rapidly cleared up and, despite the multiple checks and balances within TIRF-REMS, the drug appear at the patient’s door within 24 to 48 hours. Linden Care has recently been put up for sale by its owner, BelHealth Investment Partners. A phone call to Inder Tellur at BelHealth was not returned.


Alfonso’s legal predicament pales in scope next to the May charges filed against two pain-management physicians, Dr. John Couch and Dr. Xiuliu Ruan, partners in Physician’s Pain Specialists of Alabama in Mobile. Ranking as No. 3 and No. 6, respectively, as prolific Subsys prescribers through Medicare, in 2013, and second and first as Tricare prescribers for 2014, the pair had almost certainly become the company’s largest single revenue source.

With the two doctors arrested and charged with conspiracy to commit health care fraud and for distributing controlled substances, prosecutors released a few weeks ago a pair of affidavits that the Federal Bureau of Investigation special agents who led the investigation had filed.

Both agents described a veritable Class II drug prescription-writing factory, with prescriptions being written every four minutes and almost no medical analysis occurring from the harried physician assistants who saw the majority of the clinic’s patients. Undercover agents posing as patients with demonstrably false injury claims were barely examined yet received multimonth subscriptions for Class II drugs.

FBI Special Agent Amy White said that a confidential informant employed by Dr. Couch and Dr. Ruan described their participation in a pharmaceutical company’s speakers program as being “paid for promotion.” (While Insys was not named specifically, thc company’s identity can be deduced given the amount and timing of the payments cited.)

Similar to Alfonso’s case, the Insys speakers program is portrayed in the FBI agents’ affidavits as little more than Dr. Couch’s and Dr. Ruan’s being paid thousands of dollars for having dinner with their sales representative, according to the confidential informant. (A former Insys sales representative told the Southern Investigative Reporting Foundation that Dr. Couch and Dr. Ruan have been personally close for a decade to their Insys representative, Joe Rowan, whom they also dealt with at Teva Pharmaceuticals.)

Agent White’s affidavit alludes to the possibility that Dr. Couch abused the same class of drugs he so frequently prescribed. In a joint operation with a county drug task force, the FBI obtained the content of the trash from Dr. Couch’s residence and found that several syringe and Subsys packages had been discarded. Additionally, a confidential witness told the FBI of observing used syringes in the restroom of Dr. Couch’s personal office. Dr. Couch has a history of alcohol and prescription drug abuse, per his testimony in a California Medical Board account of the probationary certificate he was awarded in 1995, while completing a one-year pain-management residency at UCLA.

Another FBI special agent, Michael Burt, said he estimated that 50 percent to 60 percent of the clinic’s gross proceeds were derived from fraudulent activities. He said payments from Insys were found in several personal bank accounts of Dr. Couch and Dr. Ruan that he sought to seize. Another account of Dr. Ruan, Burt said, contained “kickbacks” from Industrial Pharmacy Management, a drug distributor whose founder Michael Drobot pled guilty in February 2014 to a $500 million insurance fraud scheme.

The Southern Investigative Reporting Foundation sought comment from Dr. Couch and Dr. Ruan. Neither doctor replied to multiple attempts to obtain comment.

Dennis Knizely, Dr. Ruan’s defense counsel, did respond, however, saying his client has been unfairly targeted: “These are baseless accusations, centered on the government’s interpretation [of complex issues] only. We will fight this at trial and show the government to be wrong.”

Added Knizely: “Dr. Ruan’s patients had many medical problems, including cancer, serious auto and work-related injuries. I have no doubt insurance companies have a problem with him; he ordered specific and complex procedures done to ensure the best care for his patients. His medical decisions will be shown to be sound and compassionate.”

John Beck, Dr. Couch’s lawyer, did not return multiple calls seeking comment.


One of the odder elements in Insys’ operations has been its relationship with key sales executives. In April the company sued two salespeople, Lance Clark and former Western region sales chief Sunrise Lee, for purportedly maintaining outside jobs. The company has since amended its claim against Clark but dropped the suit against Lee. A call to Clark was not returned; an inquiry to Lee was referred to her lawyer, Stephanie Fleischman Cherny, who did not respond to a request for comment.

In addition, on May 8 Insys sued Michael Ferraro, a sales representative covering southwest Connecticut for maintaining an outside interest in a compounding pharmacy. On May 28 Ferraro filed a response, claiming that he had fully disclosed his interest in the pharmacy, that he was winding it up and that he had notified the company of a series of what he alleged were federal violations stemming from an April 17 lunch with his district supervisor, Michelle Breitenbach. On July 10 Insys dropped its suit against Ferraro.

Prior to the July 4 holiday weekend, Insys dismissed Fernando L. Serrano, Dr. Freedman’s sales representative. Serrano’s LinkedIn profile mentions a stint at JPMorgan Chase as a mortgage banker but not a 2012 stint at two heavily sanctioned boiler rooms, Aegis Capital and John Thomas Financial (a firm expelled from the securities industry by the Financial Industry Regulatory Authority in 2015, along with its founder). Serrano told the Southern Investigative Reporting Foundation that he was still in shock about his Insys dismissal.

A former Insys sales executive said that the large amounts of Subsys prescriptions written by Dr. Freedman and other prescribers that Serrano had called on in 2014 had propelled him into the top-tier of revenue generators.

Serrano declined to elaborate upon why he left Insys, other than saying, “It’s just insane” several times. A follow-up call was referred to his lawyer, Ali Benchakroun, who declined to comment.

An email to Insys sales chief Alec Burlakoff and New York regional sales manager Jeff Pearlman seeking comment about the reasons for Serrano’s dismissmal were not returned.

The Southern Investigative Reporting Foundation left a voice message for Insys CEO Michael Babich and sent an email with a series of questions. He did not reply.

Additionally voice messages and emails (when addresses could be found) were sent to the top 10 doctor recipients of Insys payments in 2014 but none responded.