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The article below is the second in a two-part series. Click here to read the previous story.

Give Jonnie Williams, the CEO of recent highflier Star Scientific (Nasdaq: CIGX), some credit. By now, records indicate, Williams has proven that he can literally sell anything – cars, houses, contact lenses and, above all, risky medical stocks – even if his customers, particularly investors, often wind up on the losing end of those business deals.

Over the years, Williams has clearly polished his act. Early on, records show, he found himself sanctioned by securities regulators for allegedly paying a stock promoter to issue bullish reports on a doomed biotech company while he was secretly dumping a big chunk of his own shares. Since then, however, he has learned to distance himself from aggressive stock promotions that seem to magically erupt (along with his current company’s shares) without any obvious involvement on his part.

Take Star, for example, a combination tobacco-biotech play that boasts a market value of $600 million – more than 700 times its prior-year sales – even though the company has spent almost a decade operating in the red. Star has more than doubled since the beginning of the year, rocketing from $2 to $5 this spring alone and overcoming a recent slide (which took it back below $3) to climb back toward the $5 mark once again.

The stock peaked at $5.35 on May 31, when it closed above $5 for the first time in years and paved the way for Williams to exercise millions of newly issued options – priced below $3 a share – in the process. Williams and his family already owned more than 20 million shares in the company (including stock options and warrants) even before that, records show, a massive stake worth almost $100 million based on current market prices. He recently signaled plans to sell about 1 million of those shares in official corporate filings that registered more than 12 million shares sold earlier this year, for $2 or less, through the latest in a series of dilutive private placement deals.

Meanwhile, as the top executive of Star – a former cigarette company now pursuing miraculous breakthroughs in the healthcare arena -- Williams has spent more than a decade refining and perfecting one of his most powerful sales pitches of all. In the original script, the Richmond Times-Dispatch reported long ago, Williams somehow outsmarts Big Tobacco – with its gigantic research budgets and its fancy Ph.D. scientists – by developing a safer tobacco-curing process after experimenting with his microwave oven. He then sues industry powerhouse R.J. Reynolds (NYSE: RAI) for utilizing a similar system, the Associated Press has since explained, seeking massive damages from the tobacco giant for allegedly infringing on the patents for his remarkable invention.

For almost a decade, the Times-Dispatch later noted, that story has served as the primary driver behind Star shares – alternately sending them above $5 and below $1 – as the dramatic, yet inherently unpredictable, courtroom fight continues to unfold.

A few years ago, faced with a string of nasty legal setbacks that threatened its very survival, Star essentially swapped that worn-out script for a more compelling story. In this version, loudly trumpeted by speculative bulls, Williams has managed to outsmart Big Pharma – once again besting a deep-pocketed industry with massive research budgets and stables of well-trained scientists – by uncovering a tobacco-based substance that promises an effective new treatment for Alzheimer’s disease.

That story, bolstered by strong endorsements from even an established stock picker, gets even better. By focusing on a so-called “nutraceutical” (the glorified term for a nutritional supplement) rather than seeking regulatory approval of an actual drug – a real challenge for a tiny company that spends a pittance on research and development – Star could not only beat giant pharmaceutical companies to the market with a promising Alzheimer’s treatment, breathless fans proclaim, but the company could also realize that dream within a matter of months and see its market value instantly skyrocket into billion-dollar territory as a result.

Based on an outstanding share count of 134 million -- a number that keeps exploding because of Williams’ incredible marketing skills (and excludes warrants and options for another 40 million shares) -- Star would command at least $7.45 a share under that scenario. Once Star broke past the magical $5 mark this spring, however, skeptics began to see possible signs of yet another temporary spike that could backfire on hopeful investors once again.

“Some of its most bullish backers think shares have room to run much higher, so it’s certainly worth further research,” David Sterman of StreetAuthority.com, a well-read financial website, wrote a few months ago. “But you should also know that this stock surged in 2000, 2005 and 2009 to $5 – only to give back those gains every time.”

In the end, he concluded, “will this time be different?”

Star failed to respond to a long list of detailed questions submitted by TheStreetSweeper ahead of this two-part investigative report.

Smoke and Mirrors

Until last year, when Star suddenly enjoyed newfound status as a biotech play, the company relied on its long-running legal war against tobacco giant RJR – with damage estimates rising into the billions over time – as the primary magnet drawing speculative investors to its highly volatile shares. That story, including a colorful prologue compiled by The Boston Globe years ago, dates back more than three decades and goes something like this.

Long before Williams ever launched Star, the Globe revealed back in 1988, he established himself as “one of the best salesmen ever to hit his hometown” in Virginia by shattering records at a local car dealership and a nearby real estate office. With the help of an entrepreneurial ophthalmologist named Frank O’Donnell Jr., the newspaper reported, Williams then started his first business – Colonial Opticians – where he wound up fined for fitting contact lenses without a license before eventually abandoning the optical shop and its pile of unpaid bills.

After that, the Globe said, the pair teamed up to start several health-related companies that actually went public and then ultimately went bust. They started with an outfit called CME-SAT back in the early 1980s, the newspaper reported, capitalizing on their connections at Johns Hopkins University (where Williams sought, but never received, a graduate degree) by selling stock to college professors who starred in educational films produced by CME-SAT before the young company failed.

“Their repeated stock purchases kept the company afloat despite almost continuous losses,” the Globe later explained. “Those purchases also paid O’Donnell and Williams substantial salaries for the few years they remained with the firm.”

The pair began dumping their stock in the company two years after it went public, the newspaper reported, and then promptly resigned to start two new companies – including one that would later morph into Star itself – in the months that followed. The first company, Spectra Pharmaceutical Services, went bankrupt five years later. The second, originally known as Eye Technology, languished as an obscure penny stock until executing a reverse merger with Star Tobacco and Pharmaceuticals (since renamed Star Scientific) in early 1998, the Richmond Times-Dispatch reported at the time, when it exploded onto the market as a $6 cigarette stock.

Together with his sidekick O’Donnell, the Globe further revealed, Williams launched a couple of other public companies during the 1980s as well. (One of those, identified as C.A. Blockers, hatched a futile plan to commercialize a safer cigarette before Star later adopted that same business strategy.) They took yet another company public in 1991, this one catching the attention of Barron’s in a separate investigative report, with regulators ultimately cracking down on Williams – along with a Florida brokerage firm that helped with some of those stock offerings -- a couple of years later.

By then, the Globe indicated, the U.S. Securities and Exchange Commission had grown suspicious of almost every public company started – and often later abandoned -- by the two serial entrepreneurs.

“Neither O’Donnell nor Williams has stayed anywhere long,” the Globe observed in the meantime. “And almost everywhere they have gone, trouble has followed.”

The latter finally paid a price in 1993, the newspaper later reported, when both federal and state regulators sanctioned Williams – identified in government records as a “Florida stock promoter” -- for allegedly financing a publicity campaign that allowed him to sell discounted shares in one of his doomed companies (bankrupt Spectra) at artificially inflated prices. Years later, a 1998 news report shows, his attorney Paul Perito – now the longtime chairman of Star – would portray Williams as a naïve kid, suffering from dyslexia, who wound up duped by medical researchers connected to the company.

“Jonnie was 32 at the time,” Perito declared in that story. “He was a child.”

Either way, Williams apparently learned his lesson. After that, records show, he displayed newfound discipline by largely sticking with one company – overseeing Star through more than a decade of turbulence – and carefully keeping his distance from those who aggressively promote its stock.

O’Donnell gradually faded from the scene in the meantime, records show, scoring millions by selling his family’s big stake in Star along the way. He has spent the interim years leading his own risky biotech outfits, records show, overseeing Accentia Biopharmaceuticals (ABPI.PK) and its subsidiary Biovest International (BVTI.PK) – two penny-stock companies that trade on the lowly Pink Sheets for about 50 cents apiece – through bankruptcy, the local Tampa Bay Business Journal revealed, and losses that continued to escalate even after that reorganization effort. O’Donnell still held lingering connections to Star during that period, corporate filings show, sharing ownership with Williams in an airplane leased to the bleeding company for business trips and rights to the patented technology that sparked the high-stakes legal battle with Big Tobacco that continues to this day.

Fire and Ice

Since Williams and his partner usually focused on health-related companies, a past story by the Richmond-Times Dispatch indicates, they wound up in the deadly tobacco business almost by accident.

About two decades ago, the newspaper reported, the pair assumed control of a small cigarette maker that owed them some money and then later took the company public with bold promises to revolutionize the tobacco industry. Just weeks before merging into Eye Technology (a thinly traded Pink Sheet company) and debuting as the newly public Star Tobacco and Pharmaceuticals (now Star Scientific), corporate filings show, the company had secured exclusive rights to use a patent-pending “StarCured” process for the creation of less harmful tobacco products. Williams himself had invented that process years earlier when experimenting with his microwave oven, the Richmond Times-Dispatch later reported, and had just patented the technology with plans to charge big tobacco companies – pursuing safer cigarettes of their own – handsome licensing fees for access to his breakthrough.

“America’s major cigarette companies have spent hundreds of millions of dollars -- perhaps billions -- researching the same problem,” the Times-Dispatch stated years ago. “The jury’s still out, but some experts think Williams has outsmarted the big boys.”

When Star actually took its case to court, however, a federal judge – followed by a real-life jury – reached the opposite view. The first big blow came in 2007, American Lawyer reported that year, when a judge declared Star’s patents unenforceable because evidence (including a damaging letter from one of the company’s own consultants) indicated that the technology was not new. The judge also found “clear and convincing proof of an intent to deceive” by the company, American Lawyer added, while expressing “substantial doubt as to the professional independence” of a law firm that received “a substantial amount” of stock options for securing the disputed patents in the first place.

When the judge issued a preliminary judgment in favor of RJR earlier that year, records show, Star lost almost three-quarters of its market value – with its stock plummeting from $4.17 to $1.16 a share – over the course of a single day. Star closed below $1 for the first time ever less than two weeks later, records show, and ended that brutal year with its stock hammered all the way to just 80 cents a share.

Star responded to that legal setback by establishing a new business focused on tobacco-based breakthroughs in the medical arena, records show, giving the company a back-up plan in case its appeal of the devastating verdict ultimately failed. That same year, corporate filings show, Star further scaled back its presence in the tobacco market by abandoning its once-profitable discount cigarette business – which had generated more than $175 million in annual revenue at its peak – and selling its primary hard asset, almost 1,000 special tobacco-curing barns, to local farmers as well. (Star borrowed $29 million to finance those barns more than a decade ago, records show, and still owed almost a quarter of that sum – with all of the barns now gone – at the end of last year.)

Star staged a surprising legal comeback the year after exiting the cigarette business, records show, when it successfully overturned the judge’s ruling and arranged for a jury to decide the case instead. By the spring of 2009, the Richmond Times-Dispatch observed, the stock – fueled by confident forecasts of a big legal victory – had fully recovered from its 2007 hit and was fast approaching $5 once again.

Thanks to that powerful rally, records show, Star’s longtime chairman managed to score almost $3 million in gains by cashing in 1 million cheap stock options – and immediately selling the underlying stock -- just days before those options were set to expire. Meanwhile, during a three-month period punctuated by that well-timed sale, one particularly bullish analyst issued at least five different research reports indicating that investors should buy and hold the rising shares instead.

Otis Bradley of Gilford Securities began recommending Star at $2.67 in early March of 2009, records show, and kept recommending the stock every few weekshis enthusiasm mounting – as it marched straight toward (and ultimately beyond) the long-elusive $5 mark. By the time he issued the last of those upbeat reports, published while a jury deliberated on a verdict in the high-stakes legal case, Bradley was already calculating damage awards of at least $2.2 billion for the company and proclaiming that “high-risk, highly speculative accounts should double up (on the stock) at current levels.”

Star peaked near $6 that same day, records show, but soon fell back below $5 a share. Less than three weeks after Bradley urged speculative investors to double-down on the stock ahead of a likely multibillion-dollar damage award, records show, the stock went on to suffer a devastating blow – plunging almost 75% to barely $1 a share in a single day (with more than half of its shares changing hands) – when the jury sided with RJR by declaring Star’s patents invalid instead.

Stripped of its powerful litigation story, the sizzling hype fast cooling to lukewarm, Star soon looked like nothing more than a fading niche player in the tobacco arena – forced to scale back marketing of its once-celebrated tobacco-based lozenges due to “slower-than-expected sales” – with little to attract the speculative investors who once embraced its stock. Star fielded a delisting warning from Nasdaq in the months that followed, its stock soon sinking to an all-time low of barely 50 cents a share, and seemed to finish the year with at least one foot (if not both) firmly planted in the grave.

New and Improved

Instead, records show, Star took bolder steps into the biotech arena and – injected with a fresh dose of hype – pulled off a miraculous resurrection that pumped new life into the gasping company.

After raising millions through yet another dilutive private placement in the spring of 2010, Star proudly announced that it had signed a “research and royalty agreement” with the Roskamp Institute to formally test its tobacco-based agent as a revolutionary new treatment for Alzheimer’s disease. By then, records show, Star had already flown back to $3 a share after stock promoter John Faessel – now the company’s most reliable and visible bull – declared it his “New Best Idea for 2010.” Faessel actually began trumpeting Star’s agreement with Roskamp before the company itself released that news, records indicate, while pointing to the venture as the likely driver behind a recent surge in both the trading price and volume of the company’s rejuvenated stock.

Star then scored an even stronger endorsement when it officially announced that deal, with an influential stock picker rushing out a bullish column – boldly entitled “Did Star Scientific Just Find a Cure for Alzheimer’s Disease?” – that predicted a near-term breakthrough for the company and a corresponding breakout for its stock price.

“This product can be in the market in two to three months,” declared James Altucher, a New York portfolio manager who built up a strong following during his years as a regular contributor to TheStreet.com. And “I think this news could ultimately drive the stock to the $15 to $20 range.”

Although Star instead sank back toward $1 the very next month, the stock responded much better when Altucher followed up this March (almost a full year later) by publishing another bullish column with an even more sensational headline – “Star Scientific Just Announced They Cured Alzheimer’s Disease and Nobody Cares” – indicating that the company may have, in fact, achieved its lofty goal.

“I’m encouraged by the (Alzheimer’s) results, even if I am discouraged with the totally non-promotional way they are disseminating the news,” Altucher wrote in his new update. “This is the opposite of a pump and dump. Heck, I wish they would be a bit more promotional.”

Star officially stuck to its conservative script, however, while a growing crowd of vocal bulls worked magic on its shares.

The company won particularly frequent and favorable reviews from Faessel, records show, a former dentist (reportedly sued by a prominent client years ago over eight-figure stock-market losses) who regularly supplies bullish research to a promotional website known as SmallCapInsights that makes money by publicizing risky penny-stock names. Less than two years earlier, for example, Fassel touted NXT Nutritionals (NXTH.OB) – later exposed by TheStreetSweeper as an overhyped penny stock – in two glowing reports published by SmallCapInsights after it received 450,000 shares of restricted stock (supplemented by cash payments) from the company. NXTH skyrocketed from barely $1 to more than $3 a share over the course of the next few months, records show, but soon plummetedlosing more than half its value in a single day – and now languishes below 10 cents a share.

Faessel introduced Star as his new favorite after NXTH plunged below $1 for good, records show, with other speculative stock players eventually joining him with fawning reviews of their own. Patrick Cox, the author of a popular biotech newsletter, added his voice to that swelling chorus this spring, records show, after his self-described “good friend” John Mauldina past target of securities regulators (who has partnered with a penny-stock outfit to pitch a miracle cure for wrinkles) – reportedly passed along some exciting research about the company that ultimately led to a personal meeting with its colorful CEO.

“Williams has absolutely no doubt about the nutraceutical he has discovered,” Cox wrote after that meeting. “If you’re accustomed to speaking with extremely careful scientists, as I am, he’s nothing like that. Nothing.”

But Williams delivered such a powerful story, followed by an impressive tour of the Roskamp Institute and discussions with its research scientists, that Cox reportedly overcame his early skepticism and became a true believer instead. He spent a dozen pages gushing about Star in the next issue of his influential newsletter, records show, expressing solid faith in the company’s proposed treatment for Alzheimer’s disease (even spinning it as a possible weapon against deadly cancer as well) while portraying the firm’s leader as an accomplished entrepreneur with a proven record of success.

“I remember when Jonnie Williams invented the tobacco-curing technology that dramatically reduces carcinogen toxins,” Cox proclaimed. “He financed that research, by the way, with a small part of the fortune he had made as a major investor or co-founder in several successful biotechs.”

As detailed above, however, Williams has spent a decade trying to prove that he actually created that curing process and has recorded more telling defeats than victories in that legal war so far. He also launched more biotech failures than successes, records indicate, even if he managed to personally strike it rich – while ordinary investors lost – along the way.

Star itself has so far managed to escape that dismal fate and keep resurrecting its volatile stock, regularly lifted by the hype of bullish promoters with the power to ignite its shares. (Two years ago, records show, Star actually appeared on a list of stocks allegedly manipulated by a now-defunct brokerage firm indicted on fraud charges.) With the help of its charismatic leader, Star keeps staging fresh comebacksand raising fresh cash – by selling big dreams that, for more than a decade now, have yet to come true.

“Jonnie Williams could sell a snowball to an Eskimo,” one of his former employees stated in a local news story cited by The Boston Globe years ago. “But when it comes to backing up what he was selling, now that was another story.”

Disclosure: Through its members, TheStreetSweeper began establishing a financial position in CIGX on June 22 and will profit on future declines in the share price. It currently holds the following positions in the stock: 800 contracts for the July $5.50 puts purchased at an average price of $1.18 apiece; 350 contracts for the July $6 puts purchased at an average price of $1.54 apiece; and a total of 49,300 shares of CIGX stock sold short at an average price of $4.79 a share. TheStreetSweeper will sell the CIGX puts it acquired and cover its short position in the stock at a future date. It will update this disclosure when those transactions occur. As a matter of policy, Melissa Davis – the editor of this website and the author of this story – never takes a financial position in any of the stocks that she covers.

* Update: TheStreetSweeper closed out its short position in CIGX on July 5 through the following transactions: selling its 800 contracts for the July $5.50 puts at an average price of $1.21 apiece; selling its 350 contracts for the July $6 puts at an average price of $1.62 apiece; and covering its short position in CIGX common stock by purchasing 49,300 shares at an average price of $4.52 a share. TheStreetSweeper will be looking to establish a new short position in CIGX if the stock moves higher, and will further update this disclosure with the details of any future trades as they occur.

Source: Star Scientific: Blowing Smoke While Investors Choke?