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Questcor Pharmaceuticals (NASDAQ:QCOR) is probably the most controversial company inhabiting the biotech sector right now. Even the well-publicized issues swirling around Herbalife (NYSE:HLF) pale in comparison.

Questcor has become a lightning rod in the sector because of the expanding investigation into its marketing practices for its flagship drug Acthar Gel, the fact that some insurance companies are balking at covering the expensive drug for indications other than infantile spasms, and its cozy relationship to the Chronic Disease Fund, or CDF, is starting to become heavily scrutinized. To top it off, insiders have been selling stock - albeit under the auspices of planned sales - at breakneck pace this year.

Nonetheless, Questcor shares have defied all of these issues, appreciating an eye-popping 100% this year. And it's no secret why Questcor has soared. The company is essentially printing money from their ever-increasing sales of Acthar. Specifically, Acthar sales for the third quarter of this year were up 62% compared to a year ago, generating $227 million in revenue. In a nutshell, Acthar is on track to reach blockbuster status next year-if the whole thing doesn't come crashing down before then.

Things are going so swimmingly at Questcor that they just declared a quarterly cash dividend equal to about a 2% yield, as well as the continuation of their stock buyback program.

So is Questcor's growth story about to turn into a nightmare?

Although I've been following the story since last year after stupidly recommending Questcor as a short candidate, I haven't seen a major headwind facing the company - until now. After digging further into the Questcor short thesis, I found it tantamount to arm-waving. Citron research and various others have repeatedly hit on the fact that Acthar is a 60-year-old drug with dubious efficacy data, prednisone could probably be applied at a much cheaper cost, and insurance companies are reducing their coverage for the drug. Basically, they were throwing mud to see if anything stuck, and they paid the price this year in the face of Questcor's monstrous rally. I personally covered my short early on after realizing the stock wasn't going to falter.

That said, the shorts appear to have been onto something the entire time without being able to fully articulate it until now. And the smoking gun appears to be the CDF and its founder Michael Banigan.

Why is the CDF the lynchpin of this tale?

Questcor makes "charitable donations" to the CDF for their co-payer assistance programs, amounting to $12 million per year (see their 10-K hyperlinked above). To meet the Anti-Kickback Statute of the Social Security Act, Questcor cannot make donations for a specific drug, but they can route them to a Funded Disease State. And if you were wondering, the CDF does cover most of Acthar's current indications in their Funded Disease States (see this excellent piece here about this issue). So the CDF basically covers the co-pay for expensive drugs indicated for rare diseases like Acthar, and these monies come from the drug's manufacturers. And this is legal because the CDF is providing co-pay assistance for the Disease State, not the drug.

So if it's legal, what's the problem?

It's all about how Questcor is expanding its sales, i.e., marketing practices. There is another big problem with Acthar in that insurance companies generally require pre-authorization before the drug is prescribed, and many doctors are simply too busy to handle the paperwork. Michael Banigan's solution was to setup Sonexus Health, whose primary raison d'être is to handle this type of paperwork. Coupled with Sonexus, Mr. Banigan also setup a specialty pharmacy called CDF Rx who would distribute free drugs for Funded Diseases. On a side note, the CDF Rx's website was recently pulled after its activities starting being openly questioned.

What these three entities appear to have been doing is to use indigent patients to increase Questcor's sales of Acthar. The picture that is coming to light appears to be the following: Indigent patients would receive free drugs from CDF Rx obtained from companies like Questcor for free; Sonexus handles the pre-authorization paperwork to reduce the barrier of physician burden; and finally, the CDF would locate an insurance company willing to take on the new patients, provided the CDF covered the drug's co-pay.

Cutting to the chase, the CDF, the CDF Rx, and Sonexus appear to be a single entity designed to increase sales of drugs like Acthar. The saddest part of this whole thing is that Mr. Banigan didn't even bother to rent separate office spaces for the three entities. They are all housed at 6900 Dallas Pkwy., Ste. 200 Plano, TX 75024.

And if you were wondering, the CDF has not registered with the Better Business Bureau, and has delayed filing important tax documents disclosing its donors for years (see hyperlink above). In sum, the CDF is far from transparent in its financial dealings.

Finally, this entire issue is becoming even more bizarre now that Mr. Banigan has apparently resigned from the CDF altogether. Take that as you will, but it's odd timing to say the least.

The Heartbreak

And now I'm going to break your heart. If you think these dealings are shady - even illegal, and deserve swift punishment, I have very bad news for you. And if you are short Questcor for all the reasons listed above, you may want to think again.

Citron and others are expecting indictments to start being handed out and Questcor to fold like a cheap tent. Where they get this idea is beyond me.

Back in 2006, the CDF posed the legality of their practices to the Office of Inspector General (OIG) of the Department of Health and Human Services, who rendered this opinion:

We conclude that the Arrangement could potentially generate prohibited remuneration under the anti-kickback statute, if the requisite intent to induce or reward referrals of Federal health care program business were present

So the OIG is basically saying way back in 2006 that this was probably illegal. Yet, they go on to give this mind-blowing conclusion:

but that the Office of Inspector General ("OIG") would not impose administrative sanctions on [name redacted] under sections 1128(b)(7) or 1128A(a)(7) of the Act (as those sections relate to the commission of acts described in section 1128B(b) of the Act) in connection with the Arrangement.

Did you catch that? The OIG actually says, well your practices are probably illegal but we won't punish you for them.

Of course, material events could have changed since then, but this little ditty is probably enough to shave years after any potential jail time for anyone actually indicated. And oh, that's where it gets really crappy.

According to the Anti-Kickback Statute, the maximum penalty is a measly $50k and 5 years in jail. It would appear that the CDF knew their actions were questionable-evinced by the request to the OIG, and they decided to sally forth for one simple reason: the rewards greatly outweighed the risks.

How many of you would take millions in exchange for a max of a $50k fine and 5 years in Federal penitentiary? And let's be honest, do you really think these multi-millionaires would really receive the maximum sentence? I doubt it.

What about Questcor?

On Questcor's side of things, they can probably just deny, deny, deny. The biggest issue facing Questcor is the loss of sales if this arrangement is nixed. My bet is that by the time this investigation wraps up Questcor will have bought an entire pipeline of orphan drug candidates, and the Acthar issue will be immaterial. As Acthar sales are tracking now, Questcor could buy up an entire orphan drugmaker within the next two years. Remember, Acthar's market exclusivity runs out in 2017 anyways, forcing Questcor's hand in the issue.

In sum, I don't see Questcor getting more than a small fine for any potential issues surrounding their marketing practices of Acthar, and the shorts are on the wrong side of this one. It may not exactly be on the up and up, but Questcor is making money hand over fist.

As Balzac said, behind every great fortune is a great crime.

Source: The Curious Case Of Questcor Pharmaceuticals