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Do These Bears Have Blood On Their Claws?


Finance: INVESTIGATIONS

DO THESE BEARS HAVE BLOOD ON THEIR CLAWS?

Regulators are probing possible manipulation in short-sellers' attack on Organogenesis

For nearly a decade, a Canton (Mass.) startup called Organogenesis Inc. has been working to develop a product that will replicate human skin. Now, after spending $95 million, the company is on the verge of marketing what it calls Graftskin, which will be used to heal chronic wounds.

Developing a promising new technology hasn't been Organogenesis' biggest challenge, though. Over the past year, it has been battling several professional investors who are betting that Graftskin will never make it to the marketplace. These investors have sold short some 6 million shares of Organogenesis--44% of the outstanding float--to drive down the stock price. Short-sellers profit by borrowing stock, then selling it with the hope that they will be able to purchase shares at a lower price to replace the borrowed stock.

So-called bear raids are not uncommon. Nor are they necessarily illegal. Few, if any, participants in bear raids have been found guilty of securities fraud. But several unusual aspects of the Organogenesis attack have attracted the attention of federal prosecutors and regulators. According to people close to the investigation, the U.S. Attorney's office in Brooklyn, the Securities & Exchange Commission, and the Chicago Board Options Exchange are looking at unusual trading patterns that suggest short-sellers may be collaborating, which could constitute an illegal stock-manipulation scheme. Authorities plan to scrutinize the trading activities of such short-sellers as Gilford Partners in Chicago, White Rock Capital in Dallas, and Michael Steinhardt, who is liquidating his well-known New York investment funds.

White Rock declines comment. So does Steinhardt partner Karen Cook. Gilford managing partner H. Robert Holmes confirms that the firm has received a letter from the SEC but denies being part of any manipulation scheme.

Authorities are also focusing on Evan Sturza, a biotech-newsletter writer who is widely quoted in the financial press and who may have played a central role in the Organogenesis bear raid. The authorities are looking at whether Sturza has been illegally orchestrating a stock manipulation. And they are examining whether some investors are trading based on advance word of upcoming negative reports by Sturza, which could constitute illegal insider trading.

"ENTERTAINING." Sturza says the SEC has asked for information, but he denies any role in a manipulation. "The conspiracy story is entertaining," he says. He also denies tipping investors to upcoming reports or trading himself ahead of his reports.

Boston-based Organogenesis was founded in 1985 by Massachusetts Institute of Technology scientists. To make Graftskin, the company's core product, technicians lay down a base of collagen, a fibrous protein found in human and animal connective tissue. They then add cells from foreskins of newly circumcised baby boys. Each foreskin can be used to produce 200,000 skin patches. Unlike its competitors, Organogenesis produces full-thickness skin--both dermal and a thin outer epidermal layer. "This is an extremely promising new technology," says Dr. William H. Eaglstein, a dermatology expert at the University of Miami School of Medicine who has no ties to Organogenesis. The Food & Drug Administration is currently reviewing the company's application to market Graftskin.

Organogenesis is just the sort of company that shorts like to target: small, with experimental technology, an unmarketed product, and, as yet, no earnings. Sturza alleges such additional troubles as false product starts, management miscues, excessive optimism, and unfulfilled collaborations with other companies. "The company has been wrong for 10 years," says Sturza. "That's why it's such a popular short."

Organogenesis has met repeatedly with federal authorities to aid the federal probe. Chairman and CEO Herbert M. Stein, 67, a venture capitalist who helped get the company off the ground, and David T. Rovee, 56, the company's president, decline comment. But the company says that the bear raid has "been a distraction. We plan to vigorously protect our shareholders from this onslaught."

Organogenesis investors are more outspoken. Says Hans H. Estin, vice-chairman of North American Management Corp. in Boston, which owns a 10% stake: "In my 22 years in the business, I have never seen such abusive and vindictive tactics to knock down a stock."

BAD BUZZ. Over the past year, say Organogenesis shareholders, Sturza and an affiliate of Gilford Partners have phoned brokerages, large investors, and individual Organogenesis shareholders, advising them to unload shares or short the stock on the grounds that the company is a poor investment. They have also made apparently false claims about the company on such topics as its clinical trials, say Organogenesis shareholders who received such calls. And Gilford sent a critical letter to Organogenesis directors and telephoned a subsidiary of Sandoz Ltd., the giant Swiss drug conglomerate, when it was about to sign a marketing deal with the company. Holmes denies that Gilford phoned Sandoz and made false claims about the company. Sturza claims he called investors to "exchange information" about the company.

Holmes doesn't dispute that shorts spread the story this year that the FBI was probing whether Robert A. DiIanni, a former Organogenesis investor and an Allenwood federal prison inmate, was manipulating the stock from prison in cooperation with company execs. On Feb. 1, Gilford's Holmes wrote a letter offering to pay DiIanni a consulting fee to provide negative information about the company. On Feb. 15, CNBC correspondent Dan Dorfman prepared a report on an alleged FBI raid of the company stemming from information provided by the shorts. According to the company, Dorfman backed off when Organogenesis threatened legal action if the report was aired. A Dorfman spokesman says he has no comment.

A source in the prosecutor's office says the shorts' rumors are "absolutely false." The source adds that shorts have tried unsuccessfully to get the FBI involved. Francis J. DiMento, DiIanni's attorney, says his client never responded to Holmes and that the rumor is preposterous.

POINT MAN. Much of the bear raid has revolved around Sturza, 34, a former stock market reporter for Forbes. He sells annual subscriptions at $295 for weekly faxed reports--called Sturza's Medical Investment Letter--which he produces from his Manhattan apartment. His stock recommendations are often picked up by Dorfman and many national business publications, including BUSINESS WEEK. They frequently spur sharp short-selling in many of the 50 biotech and drug stocks he tracks.

Investigators are looking at whether Sturza receives compensation from shorts for recommending short-selling of certain companies. And they are probing whether he receives kickbacks for tipping off an inner circle of investors to negative reports as part of a scheme to drive down Organogenesis stock, sources say. "That will be tough to prove," says Sturza. "Let them look all they want."

One investment firm, which declined to be identified but is cooperating with investigators, confirmed that it pays Sturza $18,000 a year to receive phone calls from him tipping it off to reports and recommendations that will appear in upcoming newsletters. Indeed, Organogenesis trading records show several examples of increased trading two to three days in advance of Sturza's Thursday-night newsletter faxes. "The understanding is that if you make money in a stock based on the tips, you pay Sturza some cash," says a principal in the firm. If the firm makes, say, a $200,000 profit, it pays Sturza $10,000 to $20,000, according to the firm.

Sturza denies he discloses the contents of his newsletter prior to publication. But he doesn't dispute receiving compensation from investment managers who make money on his tips. "Why shouldn't you get paid?" he says. "That's the way Wall Street works." Sturza also confirms that he has shorted Organogenesis and that he trades in stocks he writes about.

HOT TIP. John E. Colley, a Saratoga Springs (N.Y.) money manager, says that a year ago, Sturza offered him the $18,000 tip service free if Colley agreed to unload his Organogenesis holdings. When Colley declined, he says Sturza told him: "If you don't want to look like a fool, unload all your Organogenesis stock. I know what's coming down, this stock is going to tank." Colley says he asked if Sturza was heeding his own advice. "My friends and family are making millions," Colley says Sturza responded. Sturza called Colley's comments "a lie."

Long-term Organogenesis investors contend that the allegedly false and misleading information about the company spread by Sturza constitutes a repetitive pattern. Over the past 14 months, Sturza has written more than a dozen articles slamming the company, some of them apparently timed to counteract positive news. Investigators are looking at whether the pattern suggests a coordinated effort by Sturza and short-sellers to manipulate the stock.

Sturza's first salvo was fired on Feb. 9, 1995, when he forecast that Organogenesis' chance of success in a key clinical trial of its Graftskin was "no more than 25%." Trading records show that volume began rising a week before the report was published. Within two weeks, amid heavy short-selling, the share price plunged nearly 40%, to about 91/2. But in March, the company announced that clinical trials showed Graftskin successful in healing chronic venous ulcers.

On May 7, Sturza claimed the stock was worth only $3 a share "given Organogenesis' dire financial position, its record of previous failures, its flawed Graftskin clinical trial results...." Trading greatly picked up 10 days before the report. In June, however, the FDA informed the company it would give an "expedited review" to its application to market the product. A month later, Stein raised $15 million in a private placement to fund further research and development.

When Organogenesis' stock nearly doubled, to 20, by early November on additional positive announcements, Sturza again went on the attack. In a Nov. 16 report, he claimed that "given Organogenesis' dire predicament...the end is near." Increased short-selling after the report pushed the share price back down 30%, to $14. The report seemed designed to deflate growing excitement about reports of an imminent marketing agreement with a major company--rumored to be Sandoz.

In November, according to an Organogenesis official, an eight-page anonymous letter was sent to Sandoz headquarters in Basel, Switzerland, outlining the shorts' criticisms of Organogenesis and warning the drugmaker to reconsider a deal. In response, Sandoz hired additional consultants to investigate the company. Organogenesis was given a clean bill of health. But the Sandoz marketing deal, announced on Jan. 17, was delayed up to six weeks by the shorts' letter-writing campaign, Organogenesis says. The licensing deal calls for Sandoz to invest up to $37.5 million and pay Organogenesis royalties, the expense of regulatory approvals outside the U.S., and marketing costs. A Sandoz spokesman in New York had no comment.

CLASS ACTION. After the announcement, short-sellers knocked the agreement and unleashed a new burst of short-selling, which pushed Organogenesis stock down 25% in three days. It was accomplished with a technique called "married puts," in which investors buy both the company's shares and puts--options to sell stock at a specified price over a specified period of time--whose expiration would be a few weeks down the road in anticipation of a company announcement. When shorts want to stifle a rise in a stock price, they sell the shares they bought on the open market, which creates downward pressure on the stock price. This, in turn, forces all put investors, not just those involved in the ploy, to sell stock to limit their losses. If several investors use the technique at the same time, the market is flooded with selling, which can drive the price down even further. Sturza confirms that the married-put technique was partially responsible for the price drop after the Sandoz announcement.

So far, short-sellers apparently have underestimated the resolve of the company and its long-term investors: Shareholders are preparing a class action against Sturza and a group of hedge funds alleging stock manipulation. Organogenesis can only hope Graftskin proves as exciting as the full-blown warfare it has sparked in the stock market.By Michael Schroeder in WashingtonReturn to top


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