Anthony Davian, a once-prolific presence on social media who held himself out as a iconoclastic hedge fund manager prior to his August 2013 indictment on a series of fraud charges, was sentenced several hours ago in a Cleveland courtroom to four years and nine months in federal prison.

Federal Judge Patricia Gaughan of Ohio's Northern District court also ordered Davian to make restitution of approximately $1.8 million to his defrauded investors and serve three years of probation after his release. Should Davian waive his right to appeal, he is slated to report to prison in late December or early January, pending his recovery from a recent foot surgery.

According to a pre-sentencing guideline federal prosecutors filed on November 18th, they sought a 60 month sentence (and full restitution) for Davian based on an investigation they claimed showed Davian had never sought to manage money, but only to raise investor capital to fund personal and business expenses, including paying off an office lease and attorney fees.

A once forceful presence on what is now known broadly as "Finance Twitter," Davian's signature remark was "Ching!" (after a trade he had been discussing allegedly turned profitable for his portfolio,) he was the subject of a July 2013 Southern Investigative Reporting Foundation investigation that raised doubts about his performance and whether he was even managing the several hundred million dollars he then publicly claimed.

In the weeks after SIRF's report was released, lawyers from the Security and Exchange Commission and the Department of Justice filed claims in federal court to shut Davian's portfolios down and seize assets. Apart from an expensive Audi and a Bath, Ohio property where Davian sought to build a mansion, there was apparently little for government lawyers to seize.

In the courtroom, according to notes given to SIRF by someone present in the courtroom who asked not to be identified because he sought "to put this behind me," Davian's wife and mother made statements that sought mercy from Judge Gaughan before the sentence was entered. His mother discussed what she argued was Davian's long history of mental illness; his wife said that all of their children had substantive medical issues that were "drowning them in medical expenses."

Davian's attorney, Paul Adamson of Akron's Burdon & Merlitti, was unavailable to comment to SIRF prior to publication, according to a colleague answering his phone.

It’s not everyday that someone makes a $373 million grant of shares in a company he co-founded, but on November 12 that’s exactly what the foundation of a fellow named Michael Karfunkel did when it gave his son-in-law’s foundation over 7.21 million AmTrust Financial Services shares.

But the seemingly innocuous grant disclosed on Friday afternoon, November 20, after the close of trading, becomes a lot more interesting when you understand that Barry Zyskind, the man who founded and manages the Teferes Foundation (the recipient of the shares) is the chief executive of AmTrust.

As Southern Investigative Reporting Foundation readers will recall from our August investigation, the 71-year old Michael Karfunkel is one-half of a fraternal duo (his brother George is six years younger) that founded AmTrust, a high-flying insurance company. What our investigation uncovered was that the two brothers' foundations—while certainly active grant-makers to synagogues and institutions connected to Brooklyn’s Haredi Judaism community—benefited mightily from using their foundations to maintain family control of AmTrust.

With that in mind, SIRF took a hard look at the deal and it appears that charity is the last reason this was done. Moreover, a close reading of the rules governing inter-private foundation transfers suggests Michael Karfunkel hasn’t done his son-in-law any favors.

In SIRF’s August story, an examination of several years worth of IRS Form 990s—the annual report for tax-exempt foundations—revealed the Karfunkel brothers had stuffed their foundations with so much AmTrust stock that they violated longstanding IRS rules governing something called “excess business holdings.”

You can be forgiven if the term doesn’t roll off your tongue, but for tax-exempt private foundations, it’s a very big deal. In short, the permitted holdings of a foundation and its disqualified persons—an IRS term for the network of foundation insiders that include its manager, their family members, the directors and key donors—boil down to a formula: 20% minus the amount held by disqualified persons. Given the Karfunkel insiders fail this test via their ownership of just over 59% of AmTrust’s shares, another IRS rule permits their private foundations to each hold up to 2% of a company’s shares outstanding.

(Starting in the late 1960s the IRS began seeking to prevent private foundations from warehousing large holdings in closely held businesses.)

So did the Hod Foundation’s grant of all of its AmTrust shares to the Teferes Foundation put it in the clear?

Not hardly.

As before, there is a long-standing rule in place that somehow Michael Karfunkel or the people advising him missed. It’s called Internal Revenue Code Section 507(b)(2) and it deals with asset transfers between private foundations. The upshot of the rule is that when 25 percent or more of the fair market value of a foundations net assets are transferred, the recipient assumes the grantor’s tax liabilities (as well as the obligation to dispose of the excess business holdings.)

In the case of Hod Foundation, this liability is potentially mounting into the tens of millions of dollars. Filings with the Securities and Exchange Commission indicate that the Hod Foundation received a block of shares on August 1, 2008 that pushed its ownership to just below 10 percent of the shares outstanding. Under IRS rule 4943, a private foundation has five years to liquidate the excess business holding; by August 2013, according to the timetable its own SEC filings document, Hod was in violation of the IRS rules.

Ultimately the Hod-to-Teferes transaction is astoundingly strange: it solves no problems and only serves to highlight the very issue it was supposed to address, and raises additional ones, like charitable intent. The Karfunkel/Zyskind private foundations remain every bit in violation of the excess business holdings rule as they were before the move and Zyskind's Teferes Foundation has been afoul of the rules from the minute the deal closed; no holding period "clock" is reset.

Getting right with the IRS will mean that some painful arithmetic is in store for the Karfunkel family.

Using the figure of 74,886,335 shares outstanding as disclosed in last week's 13-D filing, the 2% exemption means that Barry Zyskind's Teferes Foundation and George Karfunkel's Chesed Foundation for America would have to dispose of over 12 million AmTrust shares combined, either through direct sales or grants to public charities.  Breaking it down further, the maximum permissible holding for each foundation is 1,497,726 shares, implying that Teferes (which currently holds 7,347,555 shares) would have to sell 5,849,828 shares and Chesed (which currently holds 7,707,918 shares) would have to sell 6,210,192 shares.

What's more, if they donate these shares to a public charity like the United Way or the Red Cross, the donations must be unencumbered, meaning there are no strings attached—so the charity would almost certainly sell them in the open market in short order.

Given the simple remedy to this expensive problem, and the Karfunkel family’s refusal to do so, it’s obvious that maintaining this status quo is vitally important to them.

The only question remaining is why.

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A spokesman for the Karfunkel brothers, Kekst & Co’s Robert Siegfried, was asked for comment about the transaction. In response to our question about excess business holdings, he said there was “no excessive business holdings” issue and noted that Teferes was a long time donor to Jewish organizations. SIRF sought clarifications in a follow up e-mail; Kekst's Siegfried did not answer the questions and repeated his initial response.

The website of a new Minneapolis venture, EcoAlpha Asset Management, strikes a different chord for a hedge fund, holding itself out to the deep-pocketed as not just a way to maybe beat the market, but as a vehicle to economically engage with the vexing questions of access to natural resources, population growth, wealth creation and renewable energy.

Its pitch to investors is simplicity itself: as countries around the world pour countless billions of dollars into solving these problems, EcoAlpha will (presumably) benefit mightily from owning the shares of companies and the physical assets that address these issues.

Like many a nascent fund—EcoAlpha launched in early October—its investment team is heavily credentialed, with ample experience and prestige schooling. But the brief biographical sketches of  its co-founders, Win Neuger and Matthew Fitzmaurice, are most compelling for what is left out.

Neuger, as chief of AIG Global Investment Corp., engineered and oversaw perhaps the most economically destructive episode of the entire global financial crisis: AIG’s securities lending portfolio's headlong foray into mortgage-and asset-backed securities between 2005-2007, which ultimately forced the Federal Reserve to engineer a nearly $44 billion rescue. For his part, Fitzmaurice was for three years the chief investment officer and, briefly, the chief executive, of Amerindo Investments Advisors, the money management operation that was a poster child for Wall Street's Dot Com era loss of judgement.

With an investment thesis that is gaining traction as so-called Impact Investing evolves away from philanthropies and into the for-profit realm, and launched with the help of Ron Blaylock, a key fundraiser for President Obama, and a private equity executive with  his own past regulatory headache, Messrs. Neuger and Fitzmaurice want institutional capital--and plenty of it.

What they don't want, in all probability, are probing questions.

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Fitzmaurice, whose bachelors and law degree are from Georgetown University, arrived at Amerindo after a decade long stint at Wessels, Arnold & Henderson, a Minneapolis-based small-cap stock underwriter. Amerindo was famous for its outsized returns—one portfolio reportedly booked an astonishing 249% increase in 1999—making it an investor and media darling throughout the decade. But just as its massively concentrated portfolio soared as all things tech were frantically bid up, it collapsed when the Dot Com bubble burst spectacularly in the spring of 2000.

Fitzmaurice dutifully pitched Amerindo’s bull case for tech shares in the face of the rout, but Amerindo was mortally wounded and by August 2002 he had resigned. Several months prior to his leaving, The Wall Street Journal noted in a May 2002 article that in the span of just three years, Amerindo's assets under management dropped to $1.4 billion from $8 billion.

In 2005, the Securities and Exchange Commission and the Department of Justice jointly sued and indicted Amerindo’s high-profile founders, Gary Tanaka and Alberto Vilar, for allegedly misappropriating a $5 million client account as well as an alleged parallel fraud related to failing to both provide certain investors contractually guaranteed minimum levels of returns and failing to return their capital. Both were convicted and are serving lengthy jail sentences. (None of the civil or criminal cases brought against Amerindo or its founders suggested that Fitzmaurice was aware of or played any role in the fraud.)

After Amerindo, Fitzmaurice opened a pair of small hedge funds in and around Minneapolis. In 2003, he and Mitch Bartlett, a former colleague from Amerindo, put together Talaria Partners, a long/short equity fund whose details are sparse (Bartlett, now an analyst at Craig-Hallum, did not return a call seeking comment.) In 2006 he launched AWJ Partners with current EcoAlpha colleague Jonathon Clark. A type of hedge fund known as a fund-of-funds, AWJ allocated its investors capital to hedge funds with investments in water, renewable energy and sustainable agriculture. According to Securities and Exchange Commission filings, AWJ managed slightly over $47 million in assets as of February 2014; its performance results could not be obtained. (Despite Fitzmaurice’s billing as a “rising star” in hedge funds by Institutional Investor magazine, he and Clark shut AWJ shortly afterwards.)

Win Neuger, a Minnesota native and Dartmouth graduate also at AWJ with Fitzmaurice, is perhaps the least understood central character in the entire credit crisis.

[A brief personal disclosure: I wrote "Fatal Risk," a 2011 book about the collapse of AIG that featured Neuger and the securities lending portfolio story in several sections. Reached at his home prior to the book's publication and informed about its reporting, Neuger declined comment.]

Recruited to AIG in 1995 to consolidate its far-flung investment businesses, as both the company and AIG grew (in both profitability and by acquisitions,) so did Neuger's role.

By 2005, when Neuger's boss, AIG's legendary CEO Maurice "Hank" Greenberg, ran afoul of both a skittish board of directors and a crusading Attorney General named Eliot Spitzer and was forced to resign in haste that March, Neuger had become a very powerful man: he oversaw more than $700 billion in AIG Global Investment Corp. assets, sat on AIG’s executive committee and would take home a $6 million compensation package that year.

Somehow, though, it wasn’t enough. Free from Hank Greenberg's risk-management constraints, Neuger implemented a plan he called "Ten Cubed" that would have the institutional asset management unit generating a $1 billion operating profit within several years (about half the asset management unit's operating income was coming from the sale of guaranteed investment contracts.)

Central to this scheme was a sleepy corporate backwater called AIG Global Securities Lending that even long time AIG insiders were only faintly aware existed.

(By way of explanation: for life insurance companies, securities lending is an ancillary business. As policies are written and premium payments come in, insurance companies take that cash and purchase highly-rated corporate bonds whose maturities roughly approximate their expected pay off dates. Hedge funds and other money managers often need to borrow corporate bonds for a short period of time and to do so, will post as collateral the bonds par value plus a small interest rate, say $1,020, for the loan's duration. The insurance company then takes the $1,020 and buys a short-term, highly rated government bond. When the borrower takes their collateral back, the insurance company sells the government bond and keeps the accrued interest as profit.)

Neuger, whose lieutenant Peter Adamczyk oversaw the securities lending portfolio on a daily basis, managed to convince the AIG General Counsel's office to approve of a change in risk-parameters for the securities lending program, as this lawsuit alleges, without informing its "clients," e.g. AIG's various life insurance subsidiaries. (The suit was settled without terms being disclosed.)

In mid-2005, the then $60 billion AIG securities lending portfolio begin to invest borrowers' collateral in mortgage-backed securities, capturing vastly more yield but exposing them to a series of risks that were ignored when AIG insiders raised concerns.

The first risk was that the MBS purchased were known as Alt-A, a category falling between prime and sub-prime on the credit spectrum, but in 2005, with loan verification practices collapsing, these bonds were carved from loan pools whose credit profiles were deeply troubled.

Moreover, the portfolio, which had always sought to closely matched its assets and liabilities--when the bonds loaned out were due and when they were expected to return the cash collateral--was, by the end of 2006, almost $900 million skewed towards the liability side. With cash coming in as more life insurance bonds were lent out, no one was the wiser as the new cash met redemption requests from the insurer and the return of borrower's collateral.

Then the market for sub-prime bonds seized in early 2007 and the fate of AIG Global Securities Lending was sealed: the life insurers demanded their portfolios of corporate bonds returned and borrowers demanded their cash back. By late 2007 AIG was forced to use its operating cash to keep both the portfolio afloat and increasingly angry insurance regulators at bay. As market after market froze throughout 2008 even AIG's once seemingly limitless resources wouldn't be enough.

Anyone looking for evidence in AIGs corporate filings between 2005 and 2007 of the security lending program's colossal build up of assets and risks is out of luck, however, as it isn't mentioned, even obliquely.

For his part, Win Neuger never hit his "Ten Cubed" goal as the $43.7 billion Federal Reserve portfolio bailout got in the way, but as consolation, he earned just under $23 million between 2006 and 2008, including over $6.3 million in 2008, a year when AIG booked a $99.3 billion loss.

In the aftermath of AIG's bailout, Neuger was interviewed several times by congressional officials and federal regulators examining AIG's role in the credit crisis but avoided any sanction. Nor does mainstream media, as evidenced by this interview with Fox Business Channel's Maria Bartiromo, appear to have any interest in his past.

After resigning from AIG in 2009, Win Neuger became president of PineBridge Investments, AIG's old hedge fund unit that was acquired by Hong Kong-based private equity firm Pacific Century Group in 2010. He resigned in February, 2012.

In a small irony, Pinebridge's headquarters are located several floors below C.V. Starr, the insurance company helmed by his old boss, Hank Greenberg.

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The Southern Investigative Reporting Foundation made attempts via phone and E-mail to obtain interviews with Neuger and Fitzmaurice but EcoAlpha spokesman Eric Olson declined to make his colleagues available, saying by E-mail, "As a new company we prefer to remain focused on our present goals rather than participate in interviews at this time."

An earlier call to Fitzmaurice's cell was referred to Olson. A work colleague of Ron Blaylock's told SIRF via phone that he was attending a funeral and would be unable to comment.

Photo credit: Rohan Ayinde Smith

Editor's Note: This story is the result of a collaboration between SIRF and the University of North Carolina's School of Journalism and Mass Communications Fall 2014 Advanced Reporting Seminar.

By: Claire Williams, Max Miceli, Corinne Jurney, David R. Pingree, Mary Helen Moore, Brian Freskos, Kate Grise, Sarah Headley, Bradley Saacks and Jenny Surane.

North Carolina is fighting a bruising legal battle against Alcoa over the aluminum giant’s claim to a strip of the Yadkin River that it has long used to generate electricity.

At the center of the dispute are a patchwork of federal and state laws that created a quid pro quo between the two: Alcoa could operate dams to make the electricity as long as whatever they did was “in the public interest.”

The public interest in this case was Alcoa’s aluminum manufacturing operations in rural Stanly County that employed thousands over the decades.

That smelter is now gone. But Alcoa still wants the right to dam the Yadkin’s water for its electricity trading operations. The battle, in other words, stems from North Carolina’s refusal to accept that what the law defines as “in the public interest” has changed. In Stanly County, Alcoa was once a factory that turned rural farmland into a middle-class city. Now, it’s another company that sent its jobs overseas.

Alcoa abandoned Stanly County. But it still wants to use the region’s biggest resource: its water.

Whenever Judge Terrence W. Boyle hands down his decision in his Raleigh courtroom, either the state or Alcoa will have control over an asset that will put a lot of money in someone’s pocket.

A lot of eyes are watching this case. Not all of them call the Tar Heel State home. If Alcoa prevails, corporations around the country litigating similar disputes will have a powerful new federal precedent to wield in the argument over a question that few people ever think to ask: “Who owns our water?”

A high-profile divorce

For several generations, North Carolina and Alcoa had an arrangement benefiting both equally.

A state that had yet to shed its backwoods roots got the jobs and tax dollars that flowed from Alcoa’s smelter in Badin, a rural town in the Piedmont whose economy boomed as demand for aluminum soared. In turn, Badin became a company town that would never have existed if not for Alcoa.

“Alcoa built everything in the town,” said David Summerlin, chairman of the Badin Museum. “They built it all. Every kind of business was there. I mean, it was just a boomtown.”

In exchange, in 1958, the state strongly supported Alcoa’s first bid to operate a series of four dams on the Yadkin, helping convince the Federal Power Commission (now the Federal Energy Regulatory Commission) that the proposal was in the public interest.

When the FPC issued the hydropower license in February of 1958, the concept of public interest was effectively defined as Alcoa's manufacturing operations: "The operations of  [Alcoa] are a useful contribution to the industrial life of the Yadkin Valley and their continuation is greatly in the public interest."

The Yadkin was any chief executive's answered prayer: water--free and bearing little regulatory burden--providing the basis for cheap power to offset the cost of the energy-intensive smelting process; making aluminum is a competitive business and saving millions of dollars in energy costs helped the bottom line of a company that for decades was a mainstay of the American economy.

But the marriage began to crumble in 2002 when Alcoa idled the smelter. In 2007, the factory shut down and in 2010 word came down from corporate headquarters on New York City’s Park Avenue to dismantle it.

Now that Alcoa is seeking a new license to continue operating its dams for another half-century, its longtime ally has switched sides.

‘Why are we poor?’

Like many divorces, what matters is how the judge divides assets and arranges custody, and the real story isn’t found in legal claims and courtroom motions.

In this case, it’s the residents of Stanly County who have the most to say about life after Alcoa and they spin a classic before-and-after tale.

In the early years of the North Carolina-Alcoa relationship, the jobs from the smelter and its supporting industry turned the town of Badin into a regional economic powerhouse.

Workers flocked in and the influx transformed a small farming town into a middle-class community. With the plant running full bore, no one fussed about air and water quality when residents had enough income to buy a second car or send their kids to college in Chapel Hill.

And then, in a plotline many American towns know too well, the allure of lower wages and less regulation elsewhere drew Alcoa to ship jobs overseas in the early 2000s — a move aided by incentives from foreign governments that promised what Raleigh could not. By April 2010, with the plant officially closed aluminum had become to Badin what tobacco was to Winston-Salem.

With only 26 full time Alcoa employees remain and another 14 full- and part-time contractors, the shuttered factory on N.C. 740 became an unplanned memorial to a way of life, something young people would pass on their way out of Badin for good.

“If you're a young person and your family doesn't have a business here, you leave,” said Better Badin’s Bill Harwood. “We just don't have anything going on here.”

So, when Alcoa sells its juice on the wholesale market, turning a multi-million dollar profit using water it doesn’t have to pay for, that rankles some who are living Badin’s woes.

Roger Dick, who grew up in Badin and now owns a chain of community banks in the area, is adamant the dams would benefit the region more in the hands of the state.

“If you sit it an area that is rich in oil resources but it's poor, wouldn't you say, ‘What in the hell is going on?’” he said.

“So here we are. We’re rich in water. We're told it's the oil of the 21st century. But look at this place. Why are we poor?”

Photo credit: Rohan Ayinde Smith

Turning Water Into Gold

With the smelter gone, the state’s argument is that “the public interest” went with it.

Shortly after the plant was shut, North Carolina began flexing its regulatory muscles in a way that would have been virtually unimaginable a few years earlier. In December 2010, the North Carolina Department of Environment and Natural Resources, during its annual review of Alcoa’s compliance with state water quality laws, revoked a key certificate necessary for relicensing when emails emerged showing Alcoa officials acknowledging frequent, undisclosed difficulties meeting state standards for dissolved oxygen levels. (Alcoa appealed the ruling and was granted the certificate; it currently operates the dams on a yearly license.)

A longstanding cornerstone of central North Carolina’s economy, Alcoa contends that it has done so much for the state -- and is continuing to do so. The company argues in legal filings that the riverbed is practically private, pointing out that it has purchased most of the land surrounding its Badin Works facilities.

Alcoa points to a 2008 FERC ruling in defending the public benefit of its relicensing application, including the renewable, low-emission nature of its energy and that the environmental measures then suggested by FERC--if implemented--would provide the public lasting benefit. (Click here for Alcoa's full response to SIRF's question about public interest.)

Nor is Alcoa shy about framing a narrative of a government bent on usurping private property--albeit one in which a demonstrably right-wing, pro-private enterprise governor authorized the litigation.

“I don't think North Carolina wants to be known as the state that takes private property,” said Alcoa's relicensing manager, Ray Barham. “If you cave in and roll over because some government wants your property, it sets a dangerous precedent.” (In response to SIRF's questions, Alcoa said that it paid over $1.15 million in local property taxes in 2013 in addition to $163,000 in state taxes.)

Arguments notwithstanding, spending a few minutes in Alcoa’s public filings show why this fight is going to get bitter: Whoever holds the license to convert the Yadkin’s water into hydroelectric power has a small fortune in their back pocket.

According to filings from 2008 to 2010, Alcoa’s Yadkin Project is remarkably profitable, sporting a 26 percent net margin in those years. For context, Alcoa’s earnings during the same period carried a 1.2 percent net margin. Moreover, when the paper (or non-cash) expenses of depreciation and amortization are added back to net income, a truer sense of the Yadkin Project’s cash generating power emerges. In 2010, for example, almost $11.5 million in cash was created from just over $31 million in sales. Alcoa declined SIRF's request to provide updated annual operating figures for Alcoa Power Generating Inc. but said its “recent operating costs and profits are consistent with the information released in 2008-2010.”

Handsome short-term profits aren’t Alcoa’s only option, however. Should it get a new license, it could sell it (and the dams) to the highest bidder, perhaps fetching upwards of $700 million. That’s precisely what Alcoa did in 2012 when it took in $600 million from the sale of a series of similar dams in western North Carolina and eastern Tennessee to Brookfield Asset Management. Asked for comment about possibly selling APGI and its license, Alcoa declined to comment, stating it won't "speculate on potential asset sales."

(Brookfield has also been a subject of SIRF's reporting: see here and here.)

According to Alcoa, about 54% of the electricity generated from the Yadkin stays in North Carolina, including sales to Duke Energy. Based on references buried in various filings, it appears the majority of the rest of the production is sold into the Pennsylvania-New Jersey-Maryland power pool because it tends to get higher prices. (Selling into the PJM pool is attractive for Alcoa because it can also sell renewable energy credits associated with the Yadkin’s hydropower production in some of those state’s programs.)

Better Badin's Harwood--a supporter of Alcoa's bid--says he feels the company's ownership of that section of the Yadkin is already a reality.

“I’m a citizen of North Carolina, and I don’t feel like I own any of it,” he said. "Alcoa bought it, Alcoa paid for it."

The head of Badin's museum, David Summerlin, added, "I already know when they get their license they'll sell the dams. That's the opinion of everyone that's here."

The recapture battle

One of those out-of-staters watching the Raleigh courtroom and its blizzard of legal filings closely is a lawyer named Curt Whittaker, who says Alcoa’s strategy is clear enough to see.

“Allowing Alcoa to relicense means that an asset designed for the public interest is now close to being used or sold at the expense of the public’s interest,” said Whittaker, general counsel for New Energy Capital Partners LLC, a New Hampshire-based private-equity firm that takes equity stakes in renewable energy projects.

Whittaker and his colleagues have petitioned the Federal Energy Regulatory Commission to reopen the bidding process for the Yadkin Project assets in the hopes of eventually operating the dams themselves. (The fund's initial petition was rejected but they have filed an appeal.)

“Whether [Alcoa] holds or sells [the license], I’m not sure it really matters since it’s clear that apart from small payments or commitments here or there, the state of North Carolina is getting nowhere near fair value for public assets,” said Whittaker. “The profits go directly to the private sector, which is entirely apart from the law’s intent.”

The law Whittaker cites is the Federal Water Power Act of 1920. While it has been amended repeatedly, its essential nature remains unchanged: to regulate and encourage the development of hydroelectric power. The law -- now known as FPA Part I -- argues that since hydropower uses water from rivers and lakes, a public asset overseen by state governments, a hydropower project must maximize its return to the public.

Given the considerable outlays involved in building dams, licenses are awarded for 40- and 50-year terms to allow the holders time to profit from their investments.

This is not the first time that Alcoa has labored mightily to obtain a recertification to operate dams. In its 2004 bid to relicense the Tapoco hydropower project in eastern Tennessee and western North Carolina, Alcoa argued in filings that, over the 40-year term of the license, it would spend upwards of $100 million in improvements for a project that it estimated created $400 million in economic value for the Knoxville, Tennessee, area and was an important component of Alcoa’s corporate plans.

But by 2010 the smelter was shut and in 2012 Alcoa sold the Tapoco hydropower project. The project’s four generating stations and dams had become “non-core assets,” according to its press release announcing the sale.

In other words, Alcoa is fighting mighty hard to keep the type of asset it has told shareholders is not integral to its long term plans.

Proof that both sides are playing for keeps was seen in a November courtroom hearing when lawyers for both sides took a deep-dive into long-forgotten statutes, yellowing deeds and bills-of-sale from the 19th century to support positions on the Yadkin’s navigability and, ultimately, riverbed ownership. The two concepts are intertwined: Should that section of the Yadkin be found navigable, as the state asserts, then Alcoa's claims are in trouble. Alternately, under North Carolina law, non-navigable rivers can be subject to private ownership.

(In November, Judge Boyle denied Alcoa's motion for summary judgement, noting there were "genuine issue of material fact" about the Yadkin's navigability; he also denied several motions by the state. A trial date hasn't been set.)

Ground zero of the debate is likely to center on interpretations of the Federal Power Act’s recapture provisions, a section of the law that has never been used to reclaim control over a water resource. The rules may be musty but they read plainly enough: When the federal government first granted hydropower access to Alcoa, it clearly delineated its authority to take those rights back after the license expired.

"Under Section 14 of the Act, any project may be 'recaptured' at the expiration of the license term," the Federal Power Commission's brief reads. "In formulating its plans, therefore, the management of [Alcoa] could not rely upon any assured source of power supply after the expiration of its license for the Yadkin Project."

To one veteran Republican state Senator, Cabarrus’ Fletcher Hartsell, recapturing the Yadkin raised concerns that the state might be overstepping its powers. In an exchange of letters in June 2010 with the state’s Department of Justice, Hartsell expressed concerns about avoiding an infringement of Alcoa's Fifth Amendment rights. At the same time, however, he also wanted to make sure the state wouldn't be paying through the nose for rights to the river.

The state's Justice Department issued a swift reply:

"The recapture of the Project by the United States Government would not constitute a taking of the Project licensee's private property," the state's response read. "Following the recapture of the Project ... the state will not be liable to pay the current Project licensee for the profits that it would have or might have earned on the operation of the Project in the future if the Project had not been recaptured."

An environmental law analyst said the process of recapture is not so cut and dry as the state is making it out to be.

Heather Payne, a research fellow at the Center for Law, Environment, Adaptation and Resources at the UNC School of Law, said it will be a long and costly process for the state to take the license because it will have to prove eminent domain — the idea that the state has the power to take private property for public use.

It also won’t be cheap. Eminent domain requires the government to justly compensate the owner of the private property, meaning North Carolina will have to appraise the dams and their surrounding land to pay Alcoa. In 2006, as part of a requirement for its relicensing bid, Alcoa disclosed that the then fair value of the project was just under $137.5 million, representing the amount the federal government would have to pay the company "upon expiration of its license."

Payne said the state will also have to demonstrate that it could operate the dams better than Alcoa.

Local heroes

In Badin, Roger Dick’s views skeptical of Alcoa and its promises are in the minority, angering some of his neighbors so much he said he’s been called a Communist.

Not shy about couching this as a David vs. Goliath fight, Dick said, “We’re no longer barefooted. We’re no longer yeoman farmers. We can read. [Alcoa has] divided this community by telling [its] retirees and a lot of friends that we’re taking your private property. We’ve got a public document that we can show you and the world, that you know that’s not true. You know that’s not true.”

He wasn’t completely alone, at least initially.

At first, Stanly County’s Board of Commissioners vocally opposed Alcoa renewing its water quality certificate with the N.C. Department of Environment and Natural Resources — a required step for Alcoa’s relicensing efforts. But in May 2013, county leaders backpedaled with the Commissioners voting 3-2 to approve a settlement with the company. What changed? Alcoa made it worth their while. By agreeing to support the company's bid, Stanly County was given $3 million in cash, access to 30 million gallons of water per day and 20 acres of land for a water treatment plant.

One of the two dissenting commissioners, Lindsey Dunevant, read a statement before the vote that recounted Stanly County's “long, hard, uphill battle” to reclaim “what legally belongs to the people,” according to minutes of the May 6, 2013 meeting.

Dick’s assertion that North Carolina could benefit from controlling the Yadkin is not unfounded, according to Michael Shuman, an economist hired by Central Park NC, an environmental advocacy organization that participated in relicensing settlement agreement negotiations with but ultimately refused to sign off on it.

Shuman examined the prospective economic benefits of recapturing the water rights to the Yadkin, concluding the state stood to gain a potential $1.2 billion in additional revenues and between 14,000 and 75,000 jobs if it received the standard 50-year license to operate Alcoa’s hydroelectric facilities.

Alcoa is hardly back on its heels, however.

To win hearts and minds, the company went straight to the grassroots, making a multi-year effort to sway local communities to their side, getting counties, state regulators, a business group, a local realtors association and some 20 other stakeholders to sign a settlement agreement. As part of the deal, in exchange for the coalition’s support for a new license, Alcoa promised to implement measures aimed at protecting land and habitat, improving water quality and enhancing recreational opportunities along the river.

Badin, too, is slated to receive some benefits if Alcoa wins another license. The company has promised the town 14 acres along the Badin Lake waterfront, land that its leaders hope to turn into a public park.

Many in Badin project a deep-seated loyalty toward Alcoa, and ex-workers still call themselves “Alcoans.” Some of this is because of a skepticism of government activism ingrained in a politically conservative area. But it’s also because Badin is Alcoa for most residents over the age of 40.

“If the truth comes out, they’ll get the license, and they’ll get it for 40 or 50 years, and we’ll get on about business,” said Badin Mayor Jim Harrison. “They’ve been good stewards of the land; they’ve fixed every complaint that anybody’s had.”

Alcoa has long pumped money into local charities and donated the house that now serves as the Badin Museum. Since the plant closing, Alcoa has expanded these efforts to include joining forces with its old foe Stanly County to recruit industry and spent $15 million turning the site of its old plant into 700,000 square feet of prime industrial space.

The city of Albemarle, seven miles south of Badin, reached its own deal. City Manager Raymond Allen said the town will receive access to water as a back-up to the region’s local drinking supply, a promise from Alcoa to install expensive water filtration technology on its dams and a donation of land from Alcoa to both Morrow Mountain State Park in Albemarle and the Land Trust of Central North Carolina.

Photo credit: Rohan Ayinde Smith

Allen said climate change and harsh droughts are areas of concern for his city.

“So, basically, they have protected our ability to supply drinking water to our customers in this region during periods of extreme drought,” Allen said. (Albemarle has paid Alcoa roughly $15,000 annually for water.)

The access to water is especially important, Allen said, because Albemarle is concerned about being able to meet water demand as the effects from climate change set in.

One of the big concerns about private control of the water is that the license holder could regulate water flows. Alcoa’s relicensing manager Ray Barham acknowledged the fears exist, but said federal regulators can require Alcoa to provide water access.

“There’s not a lot of facts to the argument that we can restrict water,” he said. “It resonates fears with people.”

David Moreau, a research professor at UNC-Chapel Hill’s Department of City and Regional Planning, takes a middle route, saying the Yadkin could become an important source of water if the Piedmont population grows as expected.

But he also said that it does not matter whether the river is in public or private hands, as long as the license allows the water to be reallocated to public use once demand rises.

“As long as there are provisions in the FERC (license) that permit the ready transfer of water from hydropower to the urban water supply, then I don’t have much problem with Alcoa continuing to own the system,” he said.

Long Buried Problems Surface Again

The possible environmental repercussions of 50 years of aluminum smelting on Badin’s soil and water, perhaps one of the least debated components of Alcoa’s presence, may prove to be the most lasting of all.

At the center of the issue is how decades worth of so-called spent pot linings from aluminum pots were disposed in and around Badin. In 1988, the Environmental Protection Agency classified spent pot lining as toxic.

(Aluminum is smelted, or extracted, from alumina in pots. During the process, which takes several years, toxic fluoride and cyanide contaminates the used pot linings.)

In Alcoa’s case, there hasn’t been a public accounting of where the Badin smelter’s tons of pot lining were disposed of prior to 1988, according to a Yadkin Riverkeeper letter in October to a regional EPA supervisor, asking for a preliminary assessment of Alcoa’s site. The Yadkin Riverkeeper has joined the state in suing Alcoa, arguing that the river is a public trust.

Of particular note are the higher levels of aluminum-related carcinogens and toxins the Riverkeeper’s team claimed they recently found in a drainage area attached to a ball field that Alcoa recently donated to the town. (The EPA, which had a year to respond to the Yadkin Riverkeeper request, responded in 25 days and agreed to start preliminary assessments. Ryke Longest, the Duke Environmental Law Clinic lawyer representing the Yadkin Riverkeeper, said he was stunned by the EPA’s “unusually quick” response.)

That Badin might have extensive contamination is hardly surprising: As far back as 1992, Alcoa was preparing for a major cleanup at Badin when it filed suit against its insurers seeking coverage for the cost of pollution damage, investigation and remediation at its 35 manufacturing sites around the United States. At three of those sites, including Badin, Alcoa had estimated the covered claims would exceed $50 million.

The land and the water around other two sites -- in Texas and upstate New York -- were designated EPA Superfund sites; Alcoa, per the North Carolina Department of Environmental Regulation, was allowed to conduct its own cleanup. The company didn’t break any speed records in getting a corrective action plan proposal (as mandated under the Resource Conservation and Recovery Act of 1976) to the state, submitting it in 2012, nearly 21 years after the initial investigation uncovered the problem.

The Alcoa plans propose fencing off certain areas and instituting regular monitoring over actual clean up. Asked about this, Alcoa says that the North Carolina Department of Environment and Natural Resources conducted over "100 studies and reports" into its environmental practices at Badin, determined what was necessary to remediate the site and the company executed these directives. (Alcoa's response to SIRF's questions on this issue here.)

“As we tested, we found some information that tended to show contamination,” Longest said. “We also found some materials, just visually, that don’t look like they in any way, shape or form belong where they are found,” Longest said.

“Obviously, there’s going to be costs imposed to clean up this water body,” he said. “If the polluter doesn’t pay, then all the rest of us do.”

Alcoa’s Barham said the company has spent more than $12 million on cleanup, a far cry from the $50 million estimated in 1992; conversely, it has spent nearly $23 million on its relicensing bid. He said their costs today are associated with simply monitoring and sampling. Linking cleanup and relicensing is unfair, Alcoa argued in a statement, as the two issues are entirely unrelated. Moreover, according to a statement provided SIRF, the state's attempt to "take Alcoa's property" has delayed a planned water quality improvement plan worth up to $80 million.

“We understand where everything is, and it’s being monitored,” Barham said. “There’s this misconception that we’ve got this environmental issue that we have to clean up, but there’s nothing left to do.”

But Barham said he doesn’t think the site meets the requirements to be deemed a Superfund site, arguing that most bodies of water had some level of PCBs or other pollutants and Alcoa couldn’t be blamed for every trace detected.

“If you look at the times we’re below [the state’s dissolved oxygen levels, the minimum standard of which is four parts per liter], most are at 3.99, 3.98,” Barham said. “Does a fish really know the difference between 3.98 and 4.0? It probably doesn’t."

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Officials for government agencies involved in this dispute, such as the North Carolina Department of Administration and FERC, declined comment, citing the ongoing litigation; calls for comment to the North Carolina Department of Environment and Natural Resources were not returned.

Fitzpatrick Communications, an outside public relations counsel for Alcoa, provided the responses to SIRFs questions. (Click here to see all of the questions posed and their responses.)

At any given moment, Joe Donahue, a cornerstone of the popular StockTwits investing community, and a veteran of a quarter century of trading, may be making another intraday call on a stock for his community of subscribers who pay him nearly $800 a year for his trading system.

Financial social media, where a few minutes to sign up for an account is the only investment needed, allows participation in a community as active and diverse as the markets themselves. But it begs a question: Who, exactly, is giving all of this opinion and the analysis?

Far Off, Unpleasant Things

Joseph William Donahue, one of the cornerstone bloggers of—and an investor in—the popular Stocktwits investor community, is a 25-year veteran of trading. He’s done a little bit of everything including founding a pair of hedge funds: one fund that he said reached $500 million in assets and a second fund with former Major League Baseball pitcher Todd Stottlemyre. (The partnership soon split, however, with little capital apparently being raised and Stottlemyre joining multilevel marketing company ACN in 2010.)

A self-described polymath, Donahue charges a $799 annual subscription for full exposure to his positions and his many intra-day market- and trading commentaries.

For a trader looking for new perspective or some additional training, Donahue’s service may be money well spent (Donahue’s recent trading performance records are private and SIRF couldn’t obtain the track record for his two hedge funds) but for anyone with an understanding of Wall Street history, his resume alone might prompt serious second thoughts before they reach for their wallet.

According to FINRA's Brokercheck, Donahue’s career began promisingly enough in 1982 at Kidder Peabody’s retail brokerage unit and included stops at Smith, Barney, Shearson Lehman, Prudential-Bache and Oppenheimer. Apart from the fact that all of these firms are now Wall Street memories—save for Oppenheimer, which has become a troubled penny stock brokerage—they were members of Wall Street’s firmament. (The Financial Industry Regulatory Authority, or FINRA, is the self-regulatory arm of the brokerage industry that examines member firm's and their employees to ensure compliance with regulations.)

Starting in 1991, for reasons that remain unclear, Donahue took the elevator down to Wall Street’s boiler room sub-levels and stayed there for 10 years.

Regardless of Wall Street's epic failures over the past decade, they remain a distant second to the laundry list of boiler room sins. All of the shops Donahue worked at are now gone, with most banished from FINRA. A.S. Goldmen and D.H. Blair, both former employers (he was only at D.H. Blair for three months) were indicted by former New York County District Attorney Robert Morgenthau for being “criminal enterprises” and both firms would ultimately have their chief executives, as well as numerous brokers and administrators, sentenced to prison terms.

After A.S. Goldmen, Donahue joined The Boston Group (which was headquartered in Los Angeles) and headed up one of their New York offices for two years. In 1997, under heavy regulatory scrutiny for its dubious practices--including the boiler room standard, cancelling client "Sell" orders so that its inventory of "house" stocks didn't decline in price--the firm ceased operations. In 2003 FINRA permanently banned its chief executive Robert DiMinico from the securities industry.

After one of Donahue's A.S. Goldmen clients filed an arbitration in October, 1994 for allegedly mismanaging their account, FINRA assessed both Donahue and A.S. Goldmen a penalty of just over $65,000 in August, 1996.

In 2001, Donahue left the brokerage industry and founded Cornell Capital Partners with two other colleagues from the May, Davis Group (which, true to form, was expelled from FINRA in 2006.) A hedge fund that specialized in private investments in public equities, or PIPEs, the fund was profitable but had a high-profile relative to its size because its practice of structuring heavily dilutive stock transactions for its small- and micro-capitalization clients often angered investors, who saw the share price decline when the market was swamped with additional shares. Alternately, short-sellers would focus on Cornell Capital-financed deals given the inevitable decline in share price from dilution. In 2004, Donahue, along with another founder, had his partnership interest bought out for $2.625 million (the filing does not break out what percentage was paid to Donahue.)

In 2012, five years after Cornell Capital changed its name to Yorkville Advisors, the SEC sued the fund for allegedly inflating the value of its portfolio.

SIRF sought to understand why a fellow who started off with name-brand employers, a love of markets and the prospects for making real money would, after almost a decade in that world, make a beeline for firms that wound up in prosecutorial crosshairs for everything from sales fraud to organized crime links.

In an exchange of emails with the foundation, Donahue did not address his boiler room background, other than to note he has disclosed everything and that "Anyone can google me and my history." A search of his Twitter feed and his many blog posts, some going back to 2009, show that while he readily waxed nostalgic about his time at Bear Stearns and Shearson Lehman, not much was readily discoverable about his service in boiler rooms.

Describing the 1994 FINRA arbitration claim as the seemingly inevitable result of being a broker for a long period of time, Donahue said, "There will be a percentage of people that lose money and a percentage of them might make a claim. It happens."

Howard Linzon, the venture capitalist and hedge fund manager who founded StockTwits, remained in Donahue's corner, telling the foundation that he felt, "Joe is a fairly straight shooter" and that he didn't care about something that happened in the 1990s.

"Is Joe still doing that boiler room stuff now? No, he's not" he said.

Editor's note: SIRF did not calculate the size of the Longwood fund (and its three partners) in OvaScience, nor its value, using the most recent documents. It is approximately 19.5% of the 27.12 millions shares outstanding, worth just over $185.2 million. The 7 women in the Toronto test were clinically pregnant but have not delivered children. We regret the errors. Additionally, a reference to the company's cash position was reflected to include the announced proceeds from a January equity offering.

The press release went out at 1:05 p.m. last Thursday, March 26, and heralded big things for OvaScience, a barely 3-year-old company based in Cambridge, Massachusetts, that is making quite a splash peddling a pair of seemingly revolutionary procedures to assist women struggling with conception.

The company, which didn’t exist five years ago outside of the ideas in a Harvard Medical School professor’s journal articles, touted its 53 percent success rate in one of the first fertility clinics offering its AUGMENT treatment, appeared to have once again checked off a box on what has been a very fast track to success.

Indeed, by any yardstick, OvaScience’s first few years of existence should make any management team green with envy. Wall Street’s brokerage analysts are supportive of the company’s every move, investors had bid its share price steadily northward and national media provide a ready forum for management’s message.

At the center of it all is the Longwood Fund, a small venture capital outfit that raised the seed capital to get OvaScience launched. A pair of equity offerings
later, the fund’s three partners have a 19.5 percent ownership stake in the company currently then worth just above $185 million.

(Stripped down, AUGMENT is a procedure where mitochondria—the energy-generating organelles within a cell—are co-injected with sperm during an in vitro fertilization procedure called intracytoplasmic sperm injection, or ICSI. The company's theory is that the mitochondria injected from the women's ovarian lining stem cells stimulates eggs whose energy levels are diminished.)

From a business perspective, with a frantically motivated patient base and at a cost of up to $25,000 per treatment (in addition to the $10,000-$15,000 a patient can expect to pay to her physician for IVF), it's clear AUGMENT could be potentially lucrative.

But a funny thing happened on March 27: As OvaScience’s chief executive officer Michelle Dipp began a conference call around 10 a.m., recounting what the company described as encouraging news about AUGMENT’s effectiveness, the company’s shares were beginning a price collapse that would see them drop nearly 10 percent on the day, or $4.82, to $43.47.

It was a long week indeed at Longwood’s offices on Boston’s Boylston Street, as the price collapse knocked almost $300 million of market capitalization off the stock, $58 million or so of which belonged to Dipp and her partners.

So what spooked investors?

A good place to start was OvaScience’s release itself. The company claimed that 17 women had received the embryo transfer and 9 became clinically pregnant for a 53 percent success rate. But reading the release more closely shows that 26 women got the treatment and, of them, 7 were able to maintain a pregnancy for just under a 27 percent success rate.

Investors, it appears, drew a very different conclusion of what these results meant.

More importantly, given the absence of a control group, or a group of women who didn’t receive OvaScience’s treatment, discerning whether these results are troubling or promising is unknowable. Since it’s not a formal study, calculating results that might ordinarily depart from industry norms, like ignoring the full amount of women receiving the treatment, is perfectly feasible. The results can then be interpreted in a host of different ways which Dipp seized on, proclaiming at the end of the release: “Our AUGMENT treatment is having a positive impact on pregnancy rates in a variety of women who are struggling with infertility.”

Notwithstanding the difficulty posed by the absence of a control group, the Centers for Disease Control’s archive of assisted reproductive technology statistics suggests at least a broad idea of what the press release’s reported effects mean.

The median age of the women receiving OvaScience’s treatment in the Toronto clinic was 33 years old, with an average of two previous IVF treatment cycle failures.

According to the CDC in 2012 — the most recent year available for data — of the women studied who were 35 and under who failed two prior IVF treatment cycles and received IVF with fresh non-donor eggs or embryos, 33 percent were expected to deliver a live birth.

Digging further into CDC data, with the same conditions applying, for women between 35 and 37 years old, the figure is 28 percent; between 38 and 40 years old, it is 22 percent.

(Source: CDC)

The lack of data would be odd for most companies touting a revolutionary treatment for one of humanity’s most vexing issues, but OvaScience is different: Its website lacks presentations from analyst days or investor conferences, there are no speeches from its executives or scientists and, per above, there are no formal studies.

One window into the OvaScience management team’s thinking is a recent article from sciencemag.org quoting Dipp as saying, “The [fertility] industry just doesn’t do trials.” Additionally, Dipp indicated that the company — whose $60 million in cash was bolstered by a January offering that raised $132 million--readily cover the costs of any study — is unlikely to launch a trial in the near future as it is not in anything other than “a low-level ongoing dialogue” with the Food and Drug Administration.

It is no mean feat trying to reconcile what Dipp meant by “the fertility industry doesn’t do trials” with the fact that she is both a medical doctor and Ph.D. holder intimately familiar with both medical research procedure and the FDA regulations. To provide just one example, every physician prescribed oral contraceptive — and a host of other fertility assistance drugs — have been studied in formal scientific trials.

So why does a company with "Science" in its name apparently not want its own science put to the rigors of a formal scientific evaluation?

At one point OvaScience actually did (sort of) want that.

In September 2013, OvaScience announced that the FDA sent the company a letter informing them it was questioning their decision to pursue approval as a human cellular tissue product, or HCT/P, and instructing them to file an investigational new drug application. The FDA's review process for a drug is vastly more thorough (as well as time-consuming and expensive) than what OvaScience had been seeking. In response, the company said it anticipated further discussions with the FDA, suspended its then-nascent U.S. study and began to look for international testing opportunities.

For investors, Dipp's confirmation that for the forseeable future the company will not have access to the affluent U.S. market probably did little for their enthusiasm.

This is not the first time Dipp and her Longwood partners, Christoph Westphal and Richard Aldrich, have been under the spotlight for launching companies whose heavily touted prospects have been called into question.

Frankly, it's not hard to discern a pattern of sorts in how the Longwood trio handle their investments. Partner with high-profile researchers from prestigious institutions, incorporate with a mix of venture capital outfits and local celebrities, quickly cash out investors by going public, obtain fawning press coverage, leverage multiple underwritings into research analyst support, and in two instances discussed below, profitably sell the company before critical scientific flaws surface.

In April 2008, Christoph Westphal was the then-CEO of Sirtris Pharmaceuticals when he brokered a sale of the company to GlaxoSmithKline for $720 million. Two and a half years later, the giant British drugmaker shut down research into SRT501, the company’s primary drug that was being analyzed for the treatment of multiple myeloma, or cancer of the white blood cells. By 2013, all but a handful of Sirtris's remaining employees had been let go.

Prior to the shuttering of the Sirtris unit, however, matters took a surreal turn.

In August 2012, Westphal and Dipp were caught using the Healthy Lifespan Institute, a nonprofit foundation they had set up the year before, to sell synthetic supplements that were broadly similar to the SRT501 drug (at $540 for a year’s supply) they sold to GlaxoSmithKline. The day after Dipp confirmed it to Xconomy, a Boston pharmaceutical/Biotech industry news site, TheStreet.com broke the news that GlaxoSmithKline ordered them to cease selling the supplement. The company did, however, follow through with its commitment to make an initial investment in Longwood.

Another deal brokered by the trio that proved painful for a major pharmaceutical company was the July 2010 sale of the Westphal and Aldrich-founded Alnara Pharmaceuticals to Eli Lilly for $180 million. The deal was all the more impressive in that Alnara’s primary drug, Liprotamase, had been licensed to the Cystic Fibrosis Foundation in 2009 when its developer Altus Pharmaceuticals couldn’t fetch any buyers. Less than a year later, in April 2011, the FDA rejected Liprotamase for its intended purpose of treating exocrine pancreatic insufficiency. Ultimately Lilly took a $205 million write down to discontinue these operations (this figure also includes discontinuation costs for another drug).

——————————-

Concerns about the efficacy of OvaScience’s treatment program pale in comparison to the controversial history of the science — and scientists — behind the company.

OvaScience is based on the research of a pair of Ph.D.s, David Sinclair and Jonathan Tilly, former Harvard Medical School colleagues (Tilly has since become the chairman of Northeastern University’s biology department) whose research interests have combined stem cells and their fields of, respectively, aging and reproductive biology.

In August 2004, a Tilly-led research team published an article in Nature magazine that pointed to stem cells in female mice that potentially regenerated eggs after birth. The importance of the claim is difficult to understate. If it were replicated, his finding would turn accepted science on its ear, given the 50-year-old axiom that all female mammals, including humans, are born with their lifetime’s supply of eggs. A follow-up article one year later in the academic journal Cell described these ovarian stem cells as possibly residing in bone marrow and creating new eggs in as little as one day.

The articles kicked off an experimental frenzy as researchers on several continents sought to replicate Tilly’s findings.

Unfortunately for Tilly, they appear to have failed. What’s worse is that they began the reproductive biologist equivalent of a flame war, with a series of articles from fellow academics that took him to task for his conclusions.

The most potent criticism of Tilly’s work came from his then Harvard colleagues Dr. Amy Wagers and Dr. Kevin Eggan, whose research for a 2006 Nature article described their inability to induce a pair of mice — the test subjects for Tilly’s work — to produce more eggs.

The debate became so protracted that Nature wrote an editorial about it in 2006, summarizing the depth of skepticism about Tilly’s findings. To be sure, the editorial did note Tilly’s pointed objection to the Wagers/Eggan findings — that they did not precisely replicate his study — and that the egg count of the mice Wagers and Eggan worked on remained steady over time, as opposed to declining.

Dr. Roger Gosden, a recently retired co-author on the 2006 Wagers-Eggan paper, said he stands by the research investigating Tilly’s claims.

“Nothing I have seen — and very few labs are doing this work — suggests that these eggs are regenerating,” Gosden said. “Even if [Tilly] was correct in some broad fashion, other labs surely would have seen seized that research foundation and built on it. That’s not the case.”

Gosden said the inevitable attention that Tilly’s hypothesis generated in the business and media worlds raised a great deal of hope among women who were desperate to conceive.

“If there isn’t proof of replicability for a claimed discovery or process, then the scientist has an obligation to note that, even though feelings are hurt.”

Another who disputes OvaScience's scientific premise is former Jackson Laboratory scientist John Eppig, who like Gosden is a recently retired veteran of decades of reproductive biology research. “Within the reproductive biology community, there is very little support for what [Dr. Tilly] has asserted,” he said. “I suspect he misidentified [egg-]like cells that are not functionally reproductive.”

“There is also a broader question that needs to be answered from this work: Why do women go into menopause at all if there are these stem cells present?”

OvaScience’s other co-founder, Dr. David Sinclair, is no stranger to scientific controversy either. The first to theorize that Resveratrol — an organic compound found in the skin of red-wine grapes — might activate sirtuins, the proteins that influence cellular processes like aging and inflammation, his work became the framework for Sirtris Pharmaceuticals.

As noted above, while nothing short of a boon for Sinclair financially, the work proved highly controversial. In January 2010, researchers from Pfizer very publicly stated that it could not replicate any of Sinclair’s results from his original Nature paper; a month earlier, in December 2009, Amgen had more quietly challenged the very scientific premise of the drug.

When Nature magazine wrote a piece analyzing the criticisms of Dr. Sinclair’s theory, he was quoted suggesting that Pfizer’s chemists had made some elementary mistakes in attempting to replicate his work.

It would get worse: In 2011, Nature ran a study from the laboratory of MIT biology professor Dr. Leonard Guarente — Sinclair worked in Guarente’s lab prior to joining Harvard — that sharply reduced the estimates of theoretical life extension benefits from sirtuin to 10 percent to 14 percent from 15 percent to 50 percent.

Finally, as noted above, GlaxoSmithKline abandoned drug trials on Sirtris’ SRT501 in 2011, stating the drug “may only offer little efficacy” and could possibly worsen kidney problems.

Sinclair told SIRF that a series of papers he has released in the past several years, specifically one published in Science in 2013, have effectively cleared the matter up and "that the dispute you mention is no longer an issue among scientists." Additionally, on the topic of Sirtris' being shut by GlaxoSmithKline after clinical testing was halted, he said the company is fully engaged within the field of sirtuin research. (See here for the questions posed to Sinclair and his responses.)

The bitter criticism from both academic and corporate scientific colleagues sure hasn’t hurt either of their pocketbooks, though: In the S-1 filing prior to OvaScience’s initial public offering, both professors were listed as owning 701,927 shares in addition to annual consulting deals. Tilly, who has resigned from the company’s board of directors, was paid $180,000 last year as a scientific adviser; the most recent proxy filing does not mention Sinclair's name, but in response to SIRF's suggestion that his absence from the filings meant he had sold his stock, he said that the notion was "completely false."

As detailed in Sirtris' filings, Sinclair had a $150,000 per year consulting contract, was a board member and owned 242,000 shares, worth just over $5.4 million when the acquisition closed.

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Over the course of two weeks in late March, SIRF made repeated attempts to contact both Christophe Westphal and Michelle Dipp, including leaving detailed voice messages for them both at the Longwood Fund and, for Michelle Dipp, at OvaScience.

After a series of emails were sent to OvaScience’s two communications staffers, Cara Mayfield and Theresa McNeely, over the course of the same two weeks, Mayfield replied two days prior to publishing that the company "won't be able to meet [SIRF's] timeline" and would not be replying to questions.

Dr. Jonathan Tilly did not reply to a pair of emails seeking comment.

Clarification: The paragraph discussing Jeff Pearlman, Insys's New York regional sales manager, was updated to note that he was the sales and marketing chief of an aquarium company and not an installer. Moreover, he worked at a pair of medical  technology companies and didn't just broker tickets.

On the evening of July 1, 2014 Carolyn “Suzy” Markland, a 58-year old Jacksonville, Florida resident suffering from a degenerative disc disease, took her prescribed medicine—a 400 microgram dose of a Fentanyl spray called Subsys— and went straight to bed.

Despite regular pain, Subsys was not an everyday drug for Markland.  She had had the prescription filled for several months but almost never took the stuff; her longtime family doctor and pharmacist had expressed plenty of no holds barred skepticism to her about it. On the three occasions she took Subsys, her family noticed that its sedative and respiratory effects were noticeably sharper than those of another strong painkiller she took, Exalgo.

The next day, July 2, Markland went to Dr. Orlando Florete, her pain management physician for the previous five years, for a scheduled injection in her lower spine. As part of her pre-procedure anesthesia mix, she received another Fentanyl dose. Unlike previous procedures however, she wasn’t up and moving around 20-30 minutes afterwards; this time it would take about hour to where her oxygen levels would allow her to be safely released.

Markland was tired for the balance of the day, and headed in to bed early, skipping her usual cup of pre-bed decaf.

She would never wake up.

Pronounced dead at 7:01 a.m. the next morning, July 3, the Jacksonville medical examiners report listed the cause of Markland’s death as “drug toxicity,” noting the presence of both Fentanyl and Exalgo. Her death would be classified “accidental.” The report noted her family doctor refused to sign the death certificate; Dr. Florete did.

Bob Markland, Carolyn’s husband of 19 years, declined to comment apart from providing a timeline of her Subsys use prior to her death.

The medical examiner’s report of the lethal combination of the stream of Fentanyl and other drugs in Carolyn Markland’s blood is both puzzling and sad, seemingly emblematic of a strain in modern American medicine where solutions for pain can be as scarce as the medication of the pain is abundant.

In another sense, Dr. Orlando Florete also represents a parallel strain of American medicine: the physician as compensated endorser. According to the Center for Medicare & Medicaid Services’ Open Payments database, which covers just the last five months of 2013 (2014’s figures are slated for release in June), Florete was paid $18,874.03 by the makers of Subsys, a small but rapidly growing pharmaceutical company called Insys Therapeutics Inc., to travel and speak to fellow doctors.

Additionally, Dr. Florete, according to Freedom of Information Act documents obtained by SIRF, was paid $133,770.36 between January 1, 2013 and May 31, 2103 by TRICARE, the U.S. military’s primary health insurance plan, for writing 16 Subsys prescriptions.

Pharmaceutical companies compensating physicians for discussing their product--or even attending carefully-scripted seminars--is a longstanding, and legal, practice. To be certain, it has long been a concern of many within the medical community and starting in 2013, regulations were put in place to ensure disclosure of all physician payments. (Pro Publica has a wealth of information on the issue.)

A phone message seeking comment from Dr. Florete about his relation with Insys and his Subsys prescription writing was not returned as of the time of publication.

Like Dr. Florete's speaking engagements, another unremarked upon issue was the nature of Carolyn Markland's Subsys prescription: a drug indicated solely for breakthrough cancer pain was prescribed for a bad back. As with accepting pharmaceutical company payments, the law affords doctors great latitude in determining whether drugs can be prescribed for reasons other than what they are designed for. On the other hand, doctors writing prescriptions based on off-label marketing have been at the center of nearly two dozen False Claims Act legal settlements in the past 20 years, resulting in over $13 billion worth of pharmaceutical company fines and settlement payments.

In the case of Subsys, its official label--the folded paper insert with the impossibly small typeface that comes with the package--notes that it's contra-indicated for headache pain and for those who are not tolerant of the opioid class of drugs. According to the Center for Disease Control, 175,000 people died from some form of prescription opioid abuse between 1999 and 2010, compared to a combined 120,000 from heroin and cocaine overdoses.

Like Dr. Florete, Insys Therapeutics is doing pretty darn well. The company has had a remarkable level of financial success and its soaring stock price has made it a darling on Wall Street.

But that level of growth ought to warrant a raised eyebrow; going to over $222 million sales from about $15.5 million in just two years without inventing something like a better search engine is no mean feat. Fentanyl, after all, has been around for many years and while Subsys is the only spray version available, several of Insys’s competitors are well-established and better capitalized, with sales forces that reach all 50 states.

While details on the particulars of the breakthrough pain medication market are hard to find, or at least details that aren't self-serving management estimates, veteran sales staff from Insys and other pharmaceutical companies put its growth prospects at roughly 10% a year. If that's true, and the company is selling to oncologists then growth possibilities for Insys should be a function of that plus whatever they can take away from its larger competitors. Many companies would be happy for those odds.

But Insys grew north of 100%, implying that whatever organic growth they are getting is being aided by a whole lot of doctors who have grown profoundly fond of an expensive drug that brings an acre of governmental red-tape with it and that one of the largest pharmacy benefit managers will no longer touch.

The question then becomes "How?" and "Why?"

A SIRF investigation into Insys reveals that this growth has come at a remarkable price: Food and Drug Administration data shows that Subsys is proving lethal to a growing number of patients, many of whom, like Carolyn Markland, are taking it for so-called off-label indications, such as headaches and back pain.

Finally, in reporting the story, SIRF repeatedly encountered former Insys employees who had received subpoenas requiring their appearance in front of a Department of Justice grand jury that has been empaneled in Boston. Still others had been interviewed by investigators conducting an investigation for the Department of Health and Human Services' Office of the Inspector General.

A company that has been killing it--at least financially--is clearly in a lot of trouble.

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To understand Subsys the first thing you need to know is that it is literally a drug apart: a Schedule II spray administered below the tongue and dozens of times stronger than morphine, its effects are both profound, especially within the respiratory system, and virtually immediate. Which is the point, of course, given that many cancer patients suffer from nausea and cannot take pills.

To address the twin risks of addiction and overdose, in March 2012 the FDA began what it calls the Transmucosal Immediate Release Fentanyl Risk Evaluation and Mitigation Strategy, blessedly shortened to TIRF-REMS, in March 2012. At bottom, the program is designed to make obtaining a prescription for Subsys (and five other drugs) a very deliberate process, with built-in checks and balances, like confirmed opioid tolerance, signed patient statements and TIRF-certified doctors and pharmacists.

No one, in other words, is dropping a Subsys prescription off at the local CVS’ drive-through window.

Despite the unusual amount of federal guidelines designed to safeguard patients, Subsys is no stranger to adverse events.

SIRF asked Adverse Events, a California-based consultancy that collects and analyzes drug side effect data to analyze the FDA’s Adverse Event Reporting System instances of fatalities related to Subsys.

(In medical terms, an adverse event is defined as an undesirable outcome related to the drug’s use and includes categories other than death.)

Their analysis shows Subsys was referenced in 63 adverse event reports resulting in deaths since its January 2012 FDA approval. It bears noting that the FAERS database is voluntary — a prescribing physician might not learn of an adverse event related to a drug; others elect not to report them. Because of this, many in the medical industry argue—privately—that FAERS’ data skews towards the lowest potential occurrence rate.

Given the relatively sparse nature of additional FAERS data SIRF obtained (only age, gender and date of death are provided) placing the death of 63 Subsys users in a broader context is not so cut-and-dry. Certainly it’s reasonable to suppose a percentage of those prescribed Subsys have cancer and would naturally have a higher rate of mortality. Others entries list Subsys along with one or two additional drugs. Bear in mind, however, that dying of cancer isn’t usually considered an adverse pharmacological event; dying of respiratory failure when taking Subsys for a migraine is.

So how does Insys manage to grow exponentially?

The answer appears to have multiple parts: a truly unique sales force paired with a corporate speakers program that provides a stream of ready cash to frequent prescription writers.

Let’s start with sales. There’s no way around it: Insys’s sales force is very different from its competitors in the pharmaceutical industry. One reason is that a pharmaceutical sales background or even college science coursework isn’t required. Another is that if you appear to be driven and aggressive, the company will look past things that your local Starbucks might not. Scrolling through the LinkedIn profiles of Insys sales reps lends some credence to one of the assertions from an amended class action lawsuit filed against the company in October and which settled within the past week without disclosing terms: per three confidential witnesses, "most of Insys’s sales representatives were extremely attractive women." (To be fair, Merck and other leading pharmaceutical companies have long drawn attention for constructing sales forces with a large percentage of attractive women.)

Take the sales head of the New York region, Jeff Pearlman. Before becoming what his peers say is a highly productive salesmen of Class II opioids, he was the marketing and sales chief for a company that sold aquariums. Prior to that, he ran a ticket sales agency called Sitting Pretty Seating Services which, in 2004, attracted the ire of the New Jersey Division of Consumer Affairs. Shortly after, records indicate that the company's registration was revoked for not filing an annual report for two consecutive years. (Pearlman said that contrary to SIRF's implication, he had indeed worked in medical sales, having worked for a company that sold diagnostic testing equipment for  sleep apnea in the late 90's and several years later, he worked for a company that sold genetic endocrinology testing devices in the mid-2000's.)

Sunrise Lee, the recently departed head of the Central, and later Western, sales region, is also an object lesson in Insys's willingness to take a shot on a profoundly non-traditional prospect.

Before she joined the company in August 2012, Lee ran an adult-entertainment business of a sort called Sensuous Entertainment. Prior to that, she was a dancer at Rachel’s, a West Palm Beach strip club (she is to the far left in the photos; the bottom photo is of a Insys sales outing at Chicago's Wrigley Field for its top revenue producers.) It’s not clear what she did before adult entertainment.

So about a year after Lee started selling one of the six drugs so lethal that the FDA created a separate prescription protocol to monitor them, Insys promoted her to run Midwestern sales.

SIRF called Alec Burlakoff, Insys’s national sales chief, and asked him about the choice of Sunrise Lee to run sales for a quarter of the American land mass.

Burlakoff, while agreeing with SIRF’s assertion that adult entertainment is not a traditional recruiting ground for pharmaceutical companies, offered that Lee had unusual attributes that were helpful in marketing Subsys to doctors.

“Doctors really enjoyed spending time with her and found Sunrise to be a great listener,” said Burlakoff.

“She’s more of a ‘closer,’” he said, using a common sales term to describe a person who helps convince a wavering customer to purchase a product, noting that “often the initial contact [with a doctor] was made by another sales person.”

SIRF asked him about the reality of a former exotic dancer pitching a restricted drug to board-certified oncologists. He said she was more effective with pain management physicians who appreciated what he referred to as her "empathy."

“When you are dealing with [doctors] who are around pain and cancer all day, an empathetic and caring sales person is helpful,” Burlakoff said. He said that Lee had been involved in an unnamed nutriceutical company prior to joining Insys and speculated that her “holisitic approach” to the medical field might also have appealed to some physicians. SIRF, having no idea what that means, asked him to elaborate; he did not. (SIRF couldn't find or identify the company.)

For her part, Lee declined comment about Insys, noting that she had just been sued by the company—along with Lance Clark, an Insys sales executive from Dallas who had reported to her—for violating corporate policy regarding outside employment. The suits allege that she recruited physicians to use a toxicology testing company, Advance Toxicology, that was formed by Clark when he was still employed at Insys. It also alleges that she made up having earned a degree from Michigan State.

She did however confirm to SIRF that she has been in contact with both the Health and Human Service OIG and "those other prosecutors," presumably meaning the Department of Justice in Boston. (She declined to discuss it further when asked for clarification.)

Clark, who was unaware of the suit until SIRF told him about it, declined to comment.

With respect to Insys’s controversial business practices, especially the allegations of off-label sales and of payments made to physicians under its Speakers Bureau program (both of which were the subjects of New York Times investigations) Burlakoff insisted that these portrayals don't match how he and his colleagues conduct themselves on a daily basis.

“There is a very, very easy way to get fired on your first day at this company,” said Burlakoff, “And that is to mention selling off-label. We are only selling a breakthrough cancer pain drug. That’s all we want to address with a doctor.”

“You don't run a unit at a company like this by cutting corners,” he said. (Burlakoff was fired from Eli Lilly in 2003 for his role in sending out unsolicited samples of Prozac through the mail in a bid to boost the drug’s then slumping sales. He and several colleagues sued the company alleging management had approved of the plan.)

Having worked for rival drugmaker Cephalon, Burlakoff said he has run [Fentanyl] training programs “for years,” and makes clear to sales staff that their job is not to try and convince doctors but to educate them about the benefits and possibilities of a drug that can help their patient’s cope with a cancer fighting regimen.

(The Department of Justice fined Cephalon $425 million in September 2008 for its off-label sales practices, particularly of its Fentanyl product, Actiq; Burlakoff is referenced in a Qui Tam complaint filed in 2014, for allegedly ordering his staff to organize speakers program events to promote off-label prescription of its Fentanyl drug. He did not respond to a request for comment on this via email and voice message.)

SIRF asked Burlakoff about his previous assertion that the primary market for the drug was oncologists.

“Yes, well, we are trying to break in to that market but most [oncologists] only care about the tumor or malignancy and, in my opinion, don’t focus on the pain component. That’s a problem — for them and for us.”

Adding that there is a “sense that prescribing [Subsys] is something for hospice” among oncologists, Burlakoff said most oncologists that he and his colleagues deal with are happy “to refer pain treatment out” to pain management doctors so they could focus on the cancer treatment.

SIRF asked him if the pain management physicians who appear to be prescribing upwards of 90% of the drug are thus working in tandem with oncologists or are otherwise treating cancer pain. He replied that this was his understanding based on what his sales staff were telling him.

“I can say that no one at Insys wants to see anyone taking [Subsys] for anything other than cancer pain,” said Burlakoff he went on to relate several feel good stories about people whose lives have been changed because of Subsys. More substantively, he referred to discussions he has had with Insys founder John Kapoor, whose wife Edith died of cancer in 2005, that motivates him to sell a product that eases the suffering of cancer patients.

Also misunderstood, according to Burlakoff, was the role of the speakers program in Insys's sales model, said Burlakoff. It wasn’t, as the class action suit alleged via a confidential witness, “a kickback program.” Nor was it the way to incentivize a series of pain management physicians to write more prescriptions, per the depiction in a New York Times article.

Rather, “putting board-certified doctors together, where one of them is explaining the benefits he or she is seeing [from prescribing Subsys]” is the way that the drug gets acceptance. No sales rep is as effective as a doctor at convincing other doctors, he said.

“These are rich, highly-educated doctors. They have money. Whatever they are paid isn’t material.”

SIRF asked him if money wasn't the primary motivation for the doctors who Subsys paid $25,000, $50,000 or more, over the last five months time in 2013, then what did he suppose it was? Because the chart below of the top 10 payment recipients from Insys, and drawn from the CMS Open Payments data, paints a clear picture of doctors who have generated substantial income from the program. He did not reply to a request to comment on this data. (Click here to see the top 25 recipients of Insys payments.)

Many of Burlakoff's former colleagues, however, describe a very different experience with the speakers program.

A Qui Tam claim filed last year by former Insys salesman Ray Furchak alleged that the speaker program's sole purpose was, in the words of his then supervisor Alec Burlakoff, "to get money in the doctor’s pocket." The catch, as alleged by Furchak, was that the doctors who increased the level of Subsys prescriptions, and at higher dosages (i.e, moving to 400- or 800 micrograms from 200 micrograms), would receive the invitations to the program--and the checks.

The claim describes texts from Burlakoff to Furchak and other sales colleagues regularly demanding that "doctors be held accountable" and that "doctors who are not increasing their clinical experience [prescription writing], please cancel, suspend, and cease doing speaker programs.”

The Department of Justice chose not to join Furchak's suit and he withdrew it. Reached at his new job, Furchak said he stood by everything he had alleged but declined further comment.

Conversations with former sales staff support Furchak's allegations, in that the speakers program was regularly used as a lever to pressure doctors to both increase dosage strength as well as the frequency of their prescriptions for Subsys. In return, former sales staff (who were granted anonymity because of their involvement with the Department of Justice's grand jury proceedings) often had to deal with doctor's annoyed about payment levels or delays in receiving their checks.

The speaker program events have often been held at Roka Akor, a tony sushi-steak restaurant with locales in Scottsdale, Chicago and San Francisco whose owner is Insys founder John Kapoor. Based on interviews with multiple attendees, the bills often run into the thousands of dollars and given the sheer number of events, have helped his restaurants capture a handsome revenue stream. An email to chief executive officer Michael Babich seeking comment was not returned as of the time of publication.

The former sales staff also disagree that Burlakoff's full-throated rejection of off-label sales was shared by upper management. As evidence of this, two former sales staff pointed to a quarterly meeting they attended for the Southeast region sales team in Atlanta during the first week of June last year when CEO Michael Babich, during a question and answer period, read a question about the risk of off-label sales, given Cephalon's steep penalty in 2008.

“I understand why you're asking that question," said Babich. "But Cephalon didn't have TIRF-REMS; we do. You are protected because both the MD and the patient have signed it.” Asked to elaborate on this, he said that because of the TIRF-REMS requirement that the patient be extensively briefed on the risks of Subsys, there couldn't be a plausible claim that the patient (or doctor) didn't know what they were doing.

As one of the two attendees who related this event to SIRF put it, "There wasn't much else to say about the issue when your CEO sees an information protocol as an insurance policy."

Insys's assertions about serving the cancer patient aside, the company's bread is buttered by pain management and physical rehabilitation doctors, according to TRICARE's reimbursement and prescription data (the range is the most recent available, from January 1, 2013 to May 31, 2014) obtained by SIRF. TRICARE represents about 9.5 million people, or 3% of the U.S. population. For the full list of the top 25, click here.

Based on the list of the top 25 Subsys prescribers within the TRICARE system, there are 20 pain management physicians, 1 osteopath, 1 registered nurse and 3 physician assistants.

SIRF attempted to contact Dr.'s Xiulu Ruan and Patrick Couch, partners in a Mobile, Alabama practice, and the leading Subsys prescription writers by an impressive margin, to discuss this, as well as their ownership of C&R Pharmacy, which dispenses the drug to their patients. (About 50% of the Subsys dispensed in the U.S. is handled by Linden Care, a Long Island, New York-based specialty pharmacy, owned by Bell Health Ventures, a private-equity fund.)

Anthony Hoffman, a lawyer representing the practice told SIRF, “Based on your representation of the [TRICARE] data you discussed with my client, we believe it to be inaccurate and encourage you not to publish it." He did not specify what was wrong with the data and declined further comment.

As first reported in the New York Times, a series of Insys' leading prescribers have been at the center of serious allegations involving their prescription-writing practices.

Last May, federal prosecutors filed a complaint against Gavin Awerbuch, a Michigan-based pain management physician, and the company's largest prescriber (and third most compensated,) for allegedly bilking Medicare out of $5 million over a multi-year period. Prosecutors allege that he wrote 20% of the Subsys prescriptions dispensed to Medicaid recipients nationwide between 2009 and 2014 (Subsys, however, has only been FDA-approved since January, 2012.) In December of 2013, Judson Somerville, a Laredo, Texas-based pain management physician (the number eight prescriber and its most compensated,) had his prescription writing privileges "Temporarily Suspended" by the Texas Board of Medical Examiners for a host of findings, including having three patients die in a six-month period of 2012; it was not the first time he had regulatory trouble.

Stewart Grote, a Lansing, Kansas pain physician, the company's fourth biggest TRICARE prescriber (he received $8,48.05 from Insys) was sanctioned for multiple standard of care lapses and no longer is registered as a physician in the state, according to licensing records; he also had an earlier regulatory issue in 2010.

The Florida Department of Health sued Paul Wand and Miguel de la Garza, the numbers 11 and 23 TRICARE prescribers, in 2012 (Wand received $20,169.06 from Insys; de la Garza $17,019.04.) The Department alleges Wand's standard of care did not meet professional standards across a series of patients, particularly with regard to his prescription writing; with respect to de la Garza, the Department claims he did not professionally administer care to one specific patient. According to the Florida Board of Medicine's website, both cases appear to be ongoing.

Chicago-based pain management physician Paul Madison is not among the top 25 Tricare prescribers but he was the 17th most compensated. He was indicted in 2012 for an alleged $3.5 million false insurance billings scam. The case remains ongoing.

Heather Alfonso, the 25th largest TRICARE prescriber of Subsys, a Derby, Connecticut-based advanced practice registered nurse surrendered her state and federal nursing and prescription writing licenses within the past month as a Connecticut Department of Public Health investigation into her conduct remains ongoing. A February story from the Connecticut Health I-Team disclosed that in 2012, the most recent year for which data was available, she was among the nation's top 10 prescribers of Schedule II substances within Medicare's drug program.

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SIRF attempted to get CEO Michael Babich to comment via a detailed voice message left on his office phone and a pair of emails. As of publication, he has not replied.

Editor's note: A previous version of the story described Ron Blaylock as not investing in EcoAlpha. That is incorrect--he invested approximately $1 million. SIRF regrets the error.

EcoAlpha Asset Management, a hedge fund that sought to capitalize on what it touted as the looming global natural resource scarcity, closed its doors last month.

Southern Investigative Reporting Foundation readers will recall the fund from this January story that looked at the lack of disclosure surrounding the founder's backgrounds, particularly of Neuger, who was the driving force behind AIG's disastrous foray into securities lending, a gambit that required nearly $44 billion in emergency federal assistance. His actions prompted an AIG subsidiary to sue the company for its losses (a suit that was since settled with terms undisclosed.)

EcoAlpha was the brainchild of Fitzmaurice who himself was at the center of a previous Wall Street mania, having spent three years as the chief investment officer and, briefly, the chief executive, of Amerindo Investment Advisors, a money management firm whose portfolio was entirely composed of the most volatile Dot Com era shares. As a result, the fund's performance resembled a Richter scale during an earthquake, swinging from a stratospheric 265 percent gain in 1999 to a loss of 65 percent in 2000. (The founders of Amerindo, Gary Tanaka and Alberto Vilar, were sentenced to prison in 2008 for stealing client capital; there was no suggestion from regulators and prosecutors that Fitzmaurice did anything wrong.)

In the email announcing the closure, EcoAlpha's general partners said the decision was prompted by the unexpected departure of Bill Brennan, a veteran portfolio manager responsible for managing the fund's water-oriented equities. To the Wall Street veteran's eye, however, attributing a fund's failure to one partner's departure is truly unusual.

Analysts and portfolio managers regularly leave one fund for another or start their own, and while investors (more formally known as limited partners) may be concerned about departures, as long as performance is acceptable, it rarely warrants a redemption notice.

A more likely cause for EcoAlpha's closing is much more mundane: despite its high-profile investment thesis, and after more than six months in business, the fund managed to land only one substantial investment -- a $2 million investment from Columbus, Ohio's Kelley Family Foundation. As the fund was being formed Fitzmaurice told his partners that he anticipated landing a $50 million investment from Portland, Oregon investment advisory Arnerich Messina, the primary investor in AWJ Capital Partners, a fund-of-funds with an emphasis on sustainability investing Fitzmaurice had founded prior to EcoAlpha.

But Arnerich Messina did not invest in EcoAlpha. Part of the reason may be that approximately 50 percent of Arnerich Messina's capital was classified as "off-shore" for tax purposes and EcoAlpha did not have an off-shore investment vehicle. When SIRF called for comment, a colleague of company co-founder Anthony Arnerich took a message and said he was on vacation through mid-June.

Additionally, EcoAlpha had sought to launch with about $3.4 million in partner capital--including nearly $1 million each from Ron Blaylock, Fitzmaurice's Georgetown University roommate, and Neuger--but for reasons that are unclear, less than $2 million of that was invested; Blaylock, according to several former EcoAlpha officials, did not participate in a second round of financing.

A call to Blaylock's office was not returned.

With only one outside investor and just over half the agreed-upon partner capital funded, EcoAlpha cut the partner salaries 75% in January, according to an email SIRF obtained.

Fitzmaurice, reached on his cell phone on May 20, hung up when asked for comment and he did not return a follow-up call. Calls to EcoAlpha partners Jonathon Clark, Win Neuger and Elias Moosa were not returned.

Slowly but surely answers to the many riddles of how Insys Therapeutics could achieve its mercurial success are beginning to emerge.

The Scottsdale, Ariz.-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.

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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.

(In the chart, 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.

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In Hartford’s U.S. District Court on June 23, nurse practitioner Heather Alfonso of Derby, Conn., pled 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.

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, N.Y. 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.

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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.

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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.

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, 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.

Our reporting revealed that Nobles claimed a series of graduate degrees that were likely purchased from a notorious online diploma mill whose founder pled guilty to issuing fake diplomas and will be sentenced in November, according to a recent Department of Justice filing.

Additionally, we reported that Nobles’ previous efforts with publicly-traded companies were mired in controversy and investor litigation.

On October 1 Nobles filed suit against the Southern Investigative Reporting Foundation and the two authors of the article, summer intern Keith Larsen and myself, 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 Overstock.com 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; myself and board member Bethany McLean are portrayed as conspirators. It wasn't the most fertile soil for planting a flag: Deep Capture, Overstock.com 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 November 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, N.C., filed a response to the motion on November 5 that argued that Nobles’ filings didn’t meet any of the criteria for granting an injunction. The court agreed and on November 7 United States District Court Judge Louise Flanagan denied Nobles’ motion.

For the next several months both sides waged a battle of legal filings -- here is the 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 United States 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 we dropped our attempt to collect our fees. Somewhat anticlimactically, it was over, albeit thousands of dollars and a great deal of stress later.

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, Ariz.-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.

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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.

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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.

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 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

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's $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, 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.)

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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.

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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.)

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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, Calif.-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, Fla.-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.

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Everyone named in the 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.

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 issues 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 PA 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.

"[PBMs] had begun to deny Insys' [PA] 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-PA 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 PA staffers can't call on long standing professional relationships with prescribers or use speaker's 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 PBM 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 PBM 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 PA 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 PBM scrutiny and the rising level of compliance oversight required, while still allowing the unit's employees to try and guide PBMs to an approval.

The problem being, according to Montgomery, is that the PA 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. "PBMs 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 PA 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 PA 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 and deflect PBM worker questions with.

At 5:00, David Richardson a trainer with the PA 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 PA unit, begin to discuss an idea he had in response to so-called smart-scripting, whereby PBMs use software analysis to determine if a patient--per the FDAs protocol--had tried another Fentanyl drug.

(Montgomery said smart-scripting was another development that Insys' PA 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 PA 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 PBMs started requiring not only Actiq or Depomed's Lazanda, a nasal spray, but the previous use of other major painkillers like Morphine/Morphone, 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, i.e. lozenges, nasal spray or inhaler, did offer Insys an opportunity to claim that their patients could only tolerate oral inhalers. Montgomery said that PBM 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.

The number of Subsys prescriptions filled in the third quarter dropped about 4% from second quarter levels and the erosion accelerated in the fourth quarter, falling an additional 11%.

Thus far in January, the new year hasn't brought much in the way of promise, with the 815 prescriptions reported for the week ended January 15 down 6% from the comparable week a year ago. Subsys’ share of the transmucosal immediate release Fentanyl market, which hovered near 50% for most of the summer, has now fallen below 45%.

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Jana Montgomery was given a pseudonym because of her cooperation with an ongoing federal investigation. Her account of PA unit practices was read to two of her former co-workers who agreed with her characterization of "the spiel" and declining PBM authorizations.

Like 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.

Finally, a detailed message was left on Insys general counsel Franc Del Fosse's mobile phone seeking comment on these subjects. As of press time it had not been returned.

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 evidence the first.

On January 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 December 28 in the wake of the disclosure that founder and then-CEO 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 only came on February 1, three weeks after Schiller assumed control.

Schiller's July 17 separation agreement--recall that the then-CFO resigned in April after the high-profile Allergan acquisition bid collapsed to pursue other interests--sheds some light on why he ran a besieged company for over three weeks without an employment agreement in force.

The July agreement paid Schiller $2,500 per month for consulting and allowed 100,000 "performance restricted stock units" to vest on January 31, 2016 -- each unit converts into one freely tradeable share -- giving him over $9 million worth of reasons to work (temporarily) for less than an assistant manager at a fast-food restaurant.

Why Valeant woudn't 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 returned.

Seen narrowly, Schiller's new contract appears fairly standard, paying 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 in a 60-day period?

Despite 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 his looming appearance February 4 to answer questions about Valeant's drug pricing strategy for the House Government Oversight and Reform Committee .

A February 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, among other things it shows the company pursuing transactions simply for the ability to raise prices. The memorandum did not try to hide the Democrat's contempt for Pearson, mentioning him eight times in the seven-page document.

Editor's note: the initial version of this story contained two mistakes. The first misstated the amount of value from Howard Schiller's restricted stock unit grant and the second inaccurately connected him to Valeant's brief-lived "Office of the CEO." 

The mistakes were mine and I regret them.

Shortly before 11 p.m. on February 4, Valeant Pharmaceuticals chief executive officer 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 afterwards, 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 Congressman 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:

So Schiller's flight home was good. He didn't 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 take-off 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- and $3 million annually to staff, insure, house and maintain the three jets before variable costs like fuel--a 1000 nautical mile trip in the G6 uses about 860 gallons--and cabin crew. When underway, 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% 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, N.J. 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.

In 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 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% sequentially, jumping to $92 million from $67 million. It seems we can rule out Direct Success, the Farmingdale, N.J.-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) 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 upfront 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.)

    Source: Bloomberg, SEC filings

On Friday afternoon we submitted questions via email to Valeant outside spokeswoman Renee Soto of Sard Verbinnen & Co. She did not reply as of press time.

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 time-share 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 time-share, 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 Expedia.com, Hotels.com 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.)

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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.

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 time-share 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.   

Source: Diamond Resorts SEC filings. Figures expressed in thousands.

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.

What should shareholders be concerned that almost 83 percent of Diamond’s customers last year borrowed money for their week in the sun? 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 time-share 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 time-share 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 time-share 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 time-share 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.

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.

 Source: Diamond Resorts SEC filings. Figures are expressed in thousands.

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Disclosure: 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 he served as the outside spokesman for Brookfield Asset Management when it threatened to sue the Southern Investigative Reporting Foundation in February 2013.  Two SIRF board members (while working for previous employers) have written about high-profile  Sitrick & Co. clients like Biovail, Fairfax Financial Holdings and Allied Capital.

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Editor's note: A previous version of this story mischaracterized a letter written by the VOI trade association to the Consumer Financial Protection Bureau. The paragraph has been deleted.

The Southern Investigative Reporting Foundation needs your help.

Launched in 2012, at every step of the way the board of directors and myself have sought to adhere to our 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 year-long 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.

Last February spinal orthopedic device maker Globus Medical purchased Branch Medical Group, a key supplier and contract manufacturing operation based just three miles away from its Audubon, Pa. 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% 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% 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 healthcare 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% 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% 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% 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.)

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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, N.C's  Wyrick, Robbins, Yates & Ponton law firm who set it up, is a longtime Globus adviser who was listed on their 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% 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% 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.)

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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, Pa. 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%-95% of its revenues, according to Securities and Exchange Commission filings. (See Williams' full response here.)

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The Southern Investigative Reporting Foundation spent a week seeking answers to our questions via phone and email from a series of different Globus executives that were named in this story, including Brian Kearns, its new investor relations chief (if the name seems familiar, it's likely because of the SEC complaint brought against him in 2009 over his stint as a CFO of MedQuist, a failed medical billing operation. As part of a settlement, he paid $50,000.) Neither Sonali Paul or Mahboob Khan replied to a series of detailed voice messages left on their mobile phones.

Only Anthony Williams replied. Here are the answers he gave to questions posed to him.

More than seven years after Bear Stearns' collapse, its former senior leadership has pushed a narrative centering on the once-proud firm's collapse having been unforseeable.

In the telling, the metastisizing subprime crisis suddenly slipped free from fixed-income portfolios, and the only response the globe’s biggest financial institutions could muster was to cease lending, birthing a maelstrom wholly apart from any other market cycle. Cut off from vital short-term credit markets, and buffeted on all sides by self-serving rumor and the raw panic of their counter-parties and clients, Bear Stearns was forced into a fire sale.

It was “a run on the bank,” a five-word phrase stopping just short of “Act of God” in explaining the inexplicable and diffusing blame.

Two weeks ago the Southern Investigative Reporting Foundation obtained a just-unsealed lawsuit arguing the contrary: Bear’s financial health was in full-bore decline months before the June 2007 multi-billion dollar implosion of its asset management unit's two massively levered hedge funds.

The lawsuit and related exhibits were unsealed as a result of a February 5th motion to unseal the case which was granted on March 17. (Lawyers working on behalf of Teri Buhl filed the motions; Buhl is a New York City-based independent journalist whose work appears on TeriBuhl.com and Market Nexus Media's Growth Capitalist Investor.)

In September 2009 Bruce Sherman, the founder and chief executive officer of Naples, Fla.-based Private Capital Management--it once owned 5.9 percent of Bear Stearns' shares--sued its auditor Deloitte & Touche LLP and a pair of its former senior executives, chief executive officer James Cayne and president Warren Spector. Sherman’s lawyers at Boies, Schiller & Flexner LLP allege Spector and Cayne repeatedly lied to him about the firm's financial health, especially its valuation and risk management practices. (Sherman is a once revered value investor who sold Private Capital Management to Legg Mason in 2001 for $1.38 billion; he is suing over approximately $13 million of losses in his personal, charitable foundation and escrow accounts.)

Specifically, Sherman's lawyers allege that because of the numerous assurances Cayne and Spector gave him throughout 2007 and 2008 that the firm was appropriately valuing its mortgage portfolio--and thus would be unlikely to have an asset write-down large enough to affect book value--he bought additional stock. As of publication, lawyers for the two executives had not returned emails seeking comment.

Between the start of January and mid-March 2008, the value of Private Capital Management's investment in Bear Stearns declined by $478.5 million.

Bear's lawyers have insisted since January 2009 that the firm's operational risks were fully disclosed in numerous public filings and that its management did nothing wrong. Two weeks ago they filed a motion that seeks summary judgement on all of Sherman's claims. (See here for a defense team comment on the Sherman case; Joe Evangelisti, a J.P. Morgan spokesman, declined comment. )

Sherman's claim cites previously unreleased emails between key Bear executives bluntly discussing its troubled balance sheet and fretting about its declining short-term funding options. (Here is a sample.)

For example, Bear's mortgage-backed securities chief Tom Marano wrote to Paul Friedman, the repo desk head, on May 9 and May 11, 2007 discussing the firm's balance sheet which in his view already had serious challenges. "You guys need to get a hit team on blowing the retained interest bonds out asap. This is the biggest source of balance sheet problems."

When two Bear Stearns Asset Management hedge funds filed for bankruptcy on July 31, 2007--incinerating $3.2 billion of Bear Stearns's own capital--mortgage security prices collapsed, especially those that had been carved out of sub-prime mortgages. Trading volumes dropped across the entire MBS universe and the balance sheets of brokerages like Bear, Lehman Brothers and Merrill Lynch began to expand sharply as traders wrestled with not only their own mortgage inventories but billions of dollars worth of bonds sold by increasingly anxious customers desperate to reduce their MBS holdings.

What's more, Bear Stearns' management's handling of its hedge fund disaster suggested that the firm's risk management--particularly their computer models--valuation procedures and financial strength were suspect. The Securities and Exchange Commission's Office of Inspector General's September 2008 report on Bear's collapse stated that “significant questions were raised about some of Bear’ senior managements’ lack of involvement in handling the crisis.”

There is no good time for a brokerage to signal to a marketplace--especially one where they are one of the dominant players--that they own way too much of an asset class that is rapidly declining in value and that they don't have the financial resources to absorb the inevitable losses.

The summer of 2007, however, was the worst possible time to send that message.

In short order Bear's executives were working very hard to keep word of its troubled balance sheet from leaking.

Timothy Greene, co-head of the fixed income finance department, sent a June 25, 2007 email to his boss Paul Friedman, “We are being very careful not to signal any hint of liquidity distress and would not want to do so as a result of a spike in the balance sheet.”

Friedman's response: “We’re going to think how to craft the message in terms of getting rid of aged positions, paring down risk, etc. so as NOT TO spook anyone.”

A vicious circle was emerging and Bear Stearns was in the middle of it.

When the MBS market collapsed, Bear's counter-parties (who likely had their own mortgages losses to contend with) quickly began demanding higher interest-rates to enter into repurchase agreements with the firm. As repo counter-parties began to be scarce, there was nothing Bear could do--unlike commercial banks it did not have a diverse stream of funding sources--but to accept what was offered. Getting the capital to support its mortgage- and asset-backed securities stuffed balance sheet became more expensive, forcing Bear's trading profits to drop. What's worse is those MBS and ABS were dropping in value, leading to unexpectedly large write-downs. Watching the charge-offs erase book value and with no profits to offset it, customers and lenders alike began to reduce their exposure to the firm.

Bear's chief financial officer Sam Molinaro would become its public face, reliably pounding the table at every opportunity to assert that come what may, the firm's financial health was fine. On a June 22, 2007 conference call, for instance, he said the firm's "financial condition remains strong" and that it had "ample liquidity."

Unit chiefs, often facing anxious customers worried about whether their prime brokerage account at Bear was safe or if the firm would be around to meet its counter-party obligations in a derivative contract, would come to see matters differently.

Prime brokerage chief Steven Meyer, in a July 20, 2007 email to Warren Spector and Molinaro, wrote that “the impact of the hedge funds problem on the prime brokerage business is very significant, not least because it gave brokerage clients a reason to question Bear’s judgement and risk management practices.”

Meyer’s concerns were not idle.

Vicis Capital, a $5 billion hedge fund, became the first big fund to move their prime brokerage in July, 2007 to Goldman Sachs from Bear Stearns, principally over concern about the firm's MBS exposure, according to an excerpt of Sam Molinaro's deposition in the Sherman suit.

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In August, 2007 the gap between what Bear executive's told the public and what they discussed privately became pronounced.

After Standard and Poor's signaled that it was likely to cut Bear's credit rating on August 3, the firm's executives hosted a conference call to reassure investors. Molinaro again struck a confident tone and told participants that “with respect to liquidity, our balance sheet, capital base and liquidity profile remain strong.” Treasurer Robert Upton added, “Bear Stearns’ liquidity and capital position is very solid" and that "the firm’s liquidity position, capital adequacy and funding capacity remains extremely solid not withstanding the difficult market conditions.”

Yet at 7:22 am that morning Sam Molinaro sent an email to Bear’s former Treasurer and then-clearing chief Michael Minikes, “We need liquidity ASAP” after Minikes told him of the looming downgrade.

In the following days emails between Bear's executives responsible for funding its balance sheet took on an increasingly bleak tone.

On August 9, an email thread between Upton, repo chief Friedman and others discussed Bear's loss of $1.65 billion of equity repo, or repurchase agreements using stocks as collateral, as opposed to the standard government or corporate bonds. Within days it had become a torrent, and Friedman laid out the brutal details in a long email to fixed-income co-head Jeff Mayer.

To start, he told Mayer about the loss of "$14.5 billion in funding" most of which had been used to fund the MBS trading desk's whole loan and non-agency securities portfolio.

(Whole loans were loans to a single residential or commercial borrower that had not been carved into a bond. Non-agency bonds were carved from loan pools that mortgage guarantors Fannie Mae and Freddie Mac would not insure, usually because of credit concerns; these pools were the epicenter of the credit crisis.)

Nor did Friedman see any relief on the horizon.

Friedman told Mayer that "against (the loss of $14.5 billion) we’re taking in only $2.7 billion of money from [a] new source. We have an additional $3.1 billion of funding that is either already scheduled to be pulled or at risk of leaving. Roughly $500 (million) is going back this week. Another $1.9 billion is borrowed from (commercial paper) conduits that we are having trouble rolling.”

While Bear's repo desk scrambled to keep the firm funded in mid-August, Sherman seized on its declining share price as an opportunity to buy stock for his personal account and a charitable foundation he controlled, ultimately purchasing 67,000 shares in the month at prices between $110.14 and $103.15.

Throughout the fall of 2007, despite getting daily--and sometimes hourly--updates about the funding difficulties, Molinaro and colleagues proclaimed to analysts, investors and the media the strength of Bear's capital base and its access to myriad sources of funding. During the third quarter conference call on September 20, Molinaro told investors the firm was "increasing our cash liquidity pool" and had been "building excess liquidity at the parent company."

At the Merrill Lynch Banking and Financial Services conference on November 14, 2007, Molinaro said, “Our capital and liquidity position, we think, is very strong. Liquidity, in particular, is as strong as it’s ever been. We think our funding structure is very prudent, mostly secured term repo facilities.”

Molinari presented a slide that said as of Aug 31, 2007 the totality of Bear's subprime securities exposure was $1.558 billion.

Yet in a January 2008 reply to an SEC letter seeking clarification on Bear's subprime risk disclosures in 2007, Molinari said it was $2.97 billion as of August 31, 2007. He wrote that the firm had $770 million worth of retained interests in subprime securitizations and $2.2 billion of investments in securities backed by subprime loans.

The Southern Investigative Reporting Foundation called Molinaro, now the chief operating officer at UBS's investment bank, to ask about this $1.41 billion differential in subprime exposure. He did not reply to voice messages left on his cellphone and his house.

Bear's constant stumping about its solid financial health didn't work with the constituency that most mattered: its lenders.

By mid-December, according to Sherman's claim, Friedman wrote to Marano in an email that even if Bear was not downgraded and managed to “raise a couple [of] billion dollars of new equity [it would] still have all the same funding and liquidity issues [it has] now."

Three days later, Marano emailed the new CEO Alan Schwartz, to demand capital be raised immediately: "The repo desk is in a constant state of concern with respect to funding the firm. We have inadequate long term and short term financing facilities. . . . We may have inadequate funding resources to address investment in technology for risk management and reporting of positions."

The Southern Investigative Reporting Foundation spoke to Tom Marano--now the Denver-based CEO of vacation-marketer Intrawest--and he said that, "While I was pretty hard on Alan, it was necessary. We needed more capital but I didn't get through to him." Marano declined additional comment about the case.

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An exhibit that was attached to Sherman's claim shows that the SEC was alert to Bear Stearns' looming problems by late 2005 but granted "confidential treatment" status to its communications with the firm, thus exempting it from being publicly uploaded.

In its review of Bear's 2005 10-K filing, the SEC had some pointed concerns about its disclosures of subprime MBS exposure and its failure to implement a firm wide value-at- risk limit. The SEC's 2005 examination concluded that Bear's risk management framework was problematic, relying on “outdated models created over a decade ago” and that Bear had “limited documentation on how the models work.”

Sherman's lawyers allege that Bear’s risk management apparatus was nothing like the best-of-breed unit it portrayed to the public. Instead, they allege that the trading department came to dominate risk management operations. According to the 2005 SEC examination, Bear used a “bottom-up,” trader driven approach where “risk taking is evaluated first and foremost at the trading desk level.” Moreover, the SEC's analysts found that “certain business heads can establish new trading limits and approve existing limit breaches with their sole written approval without direct approval from risk management.”

His lawyers also point to a report commissioned by Bear’s board in 2007 that assessed Bear’s risk management operations. The outside consultancy, Marsh & McLennan's Oliver Wyman unit, wrote that “Bear’s risk policy and limits were proposed by the business units and frequently overridden.”

Bear even admitted in their January 31, 2008 response to the SEC the possibility of their subprime exposure potentially being fatal.

“We believe that based on the Company’s level of involvement in subprime lending and the broader impact on the global credit markets, a material adverse impact on the Company’s: financial condition, results of operations or liquidity is reasonably possible.”

They went on to promise the SEC “in future filings we will consider our level of involvement in subprime lending, and we will seek to enhance our disclosure of positions, if necessary.”