The Dark Side Of A Wonderful Investment Story

by: Derek Lowe

Biopharma investing has been a constantly erupting geyser of cash these last few years, and wherever there is that amount of money flying around, you will find people ready to help make it disappear. And you'll find people who are willing to stretch the truth in any way that they find necessary to get in on the action.

The latter is what this article at the Boston Globe details. It's on Frank Reynolds, founder of InVivo Therapeutics (NASDAQ:NVIV), who is testing a new surgical adjunct to spinal cord injury. Reynolds had a dramatic story of working his way back after such an injury himself, coming out of a terrible car crash (note: don't spend too long reading that 2010 profile until you read a bit more about Reynolds) that left him nearly paralyzed. He made it to a Sloan Fellowship at MIT, and there met Bob Langer, to whom he confided his hopes to start his own company. He certainly came to the right guy there since Langer starts companies as quickly as most people order lunch. He took on an idea that Langer's group was exploring (a sort of sponge that spinal nerves could use as a scaffold after injury) and made the case for starting a whole company around it, and thus InVivo Therapeutics was born.

I won't detail every twist and turn, but let's just say that Reynolds left InVivo in the summer of 2013, leaving quite a trail behind him. High-level employees were walking out the door (or threatening to) if they had to continue working with him - Reynolds was almost a caricature of a hard-driving, profane, abusive boss. And he himself was complaining to Langer and everyone who would listen that he wasn't being properly compensated on just $545k/year, but it appears that he was spending company money on Broadway shows, first-class air travel, and visits to the finest strip joints up and down the East coast (these expenses are currently being litigated). Oh, and he was never in that terrible car crash. He hurt his back unloading a snack-cake delivery truck in 1991. And he was never paralyzed, although he did have complications from back surgery, but that's not quite as good a story, is it?

Reynolds went on to form another company, with the worryingly odd name of PixarBio (OTC:PXRB), but that's not going so well, either. He and his associates in that venture appear to have left a substantial debris field of false statements, misrepresentations, and stock manipulation, and in April, Reynolds himself was arrested on charges of having defrauded 200 investors. He is presumably spending more time in court than in the strip clubs these days, and probably has no one left to send his table-pounding expletive-filled emails to, other than perhaps his own lawyer, which wouldn't be a good plan.

And talk of stock manipulation brings me to this separate story from Friday. A group of busy, hard-working biotech investors and executives have been charged by the SEC with defrauding investors in pump-and-dump schemes. These involved three penny-stock biopharmas and the way the schemes worked is the way that they have always worked, the way that some are working right now this very morning, and the way that stock fraud schemes will work until our sun starts exhausting its hydrogen fuel and cooks the Earth. Here's how that goes:

Across all three schemes, Honig was the primary strategist, calling upon other Defendants to buy or sell stock, arrange for the issuance of shares, negotiate transactions, or engage in promotional activity. In each scheme, Honig orchestrated his and his associates' acquisition of a large quantity of the issuer's stock at steep discounts, either by acquiring a shell and executing a reverse merger or by participating in financings on terms highly unfavorable to the company. In every scheme, Honig, and soiree combination of Stetson, Brauser, O'Rourke, Groussman and Frost, either explicitly or tacitly agreed to buy, hold or sell their shares in coordination with one another, knowing that a pump and dump was in the offing that would allow them all to profit handsomely. Once Honig and his associates had secured substantial ownership of the issuer, they acted as an undisclosed control group, directing the issuer's management for their benefit, including orchestrating transactions designed to create market interest in the company or to solidify their control.

To profit from their investment, in each scheme, Honig and his associates would arrange and pay for the promotion of the stock, directing their co-defendant Ford, or a similar promoter, to write favorable and materially misleading articles about the company whose stock price they wanted to inflate. In several instances, to magnify the intended boost to volume and price that would follow a promotional article's release, Honig, Brauser, O'Rourke, Groussman, Melechdavid and ATG engaged in pre-release manipulative trading to generate a misleading picture of market interest in the company's stock, priming investor interest.

Would you like to read one of those paid-for stock promotions? Well, they're still up (for now) on the Seeking Alpha site, so have a look. What you're reading is fiction, complete fraudulent fiction. Its author is the Ford named in the SEC complaint, and he was paid to write this garbage, for the explicit purposes of pumping up the price of "Biozone" so the shares could be unloaded onto the unwary. The article (for example) would have you believe that the company under discussion had a technology ready to go into clinical testing when the truth was that all R&D efforts had already been shut down, and nothing was ever going to be tested at all. The article states that its author had not been compensated for writing it, although three days before he'd been offered a pile of below-market-price shares to do just that. And on and on.

Does this stuff work? Why yes indeed. Biozone's trading volume went from zero shares traded, its usual daily performance, to a few thousand shares a day, to a few million within days of the promotion. The stock price nearly doubled, and trading stayed up for the next couple of months. Some of that trading was, of course, all the insiders shoveling their own shares (about 15 million of them) into the bonfire, at a rate (and with a lack of disclosure) that is totally illegal. But the buyers for these had been lined up by the promotional drum-beating. There are other articles about Biozone to be found on Seeking Alpha from that period, by people not named in the SEC indictment, and you can make of that what you will.

Taken together, these stories I'm writing about today (there are plenty more) show what anyone in this business should be aware of already: there's a lot of bulls out there. You will probably have noticed that the remains of Theranos have just been sold off for scrap (no word of any boxes of black turtlenecks in the lot), and that's just an unusually high-profile example that is different mainly in degree from what happens all the time. There are articles in what should be reputable sources that are completely unreliable - at the high end of the scale because the reporters believed the great story that someone told them, and at the low end because it's a deliberate fraud from top to bottom. Glowing articles about technologies, companies, and founders should always be subjected to scrutiny because the incentives to make things look better than they are very strong. It does not help that there is such a constantly refilling supply of people yearning, sweating, and panting, to be parted from their money: the folks in the SEC complaint took in at least $27 million from investors who piled into unknown penny stocks based on some articles by a dude on Seeking Alpha. There will be people ready to take advantage of such customers as long as the carp rise up to the feeding hand. Just try not to be one of the fish.

Disclosure: None