Ten months ago we wrote that Opko Health (NADSAQ:OPK) was a “House of Cards Tumbling in the Dark“. On Friday afternoon the SEC filed litigation against Opko’s Chairman & CEO Phil Frost, Opko Health Inc., and multiple other related entities and individuals. The complaint’s blistering allegations accuse Frost and Opko of aiding and abetting multiple pump & dump schemes led by notorious penny stock financier Barry Honig.
Frost stands personally accused of violating 7 sections of the Exchange and Securities Acts. Per the SEC complaint:
“In every scheme, Honig, and some 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.”
Following the SEC complaint, Opko’s stock plummeted 18% before being halted.
Several signs point to the strong possibility that criminal charges could follow. The complaint referenced “Company A” which has been identified by the WSJand others as Biozone Pharmaceuticals (now called Cocrystal, NASDAQ:COCP). In early 2017 investigative reporter Teri Buhl wrote that the FBI and the California Department of Justice (DoJ) had been involved in the investigation of Biozone. Per the article:
This reporter has seen a letter from the FBI that states this person is a potential victim of securities fraud. A check in the FBI’s victim notification system, seen by this reporter at press time, show the investigation is still active but doesn’t list specifically who the investigation is about. Biozone is the only company the person interviewed by the FBI held stock in.
Note that the SEC is a civil agency, whereas the FBI/DoJ are focused on criminal matters. If a civil matter is referred for criminal prosecution (or if the FBI/DoJ requests the SEC’s expertise on securities matters) then the two will often work together. The apparent coordination between the DoJ and the SEC indicates that parallel criminal charges could follow these SEC civil charges.
Indications show that both civil and criminal agencies are continuing to build its case, which further indicates that more news could follow. The SEC’s litigation release on Friday stated that there is a “continuing investigation”. Days ago, Buhl wrote on twitter:
“…based on multiple sources the FBI has recently been interviewing new informants in this case.”
Lastly, the SEC will often provide notice of its intent to sue and seek to negotiate a settlement with parties in advance. Based on Opko’s statement on Friday evening it appears the SEC had not afforded Frost & Opko the opportunity to settle. Per the statement, “the SEC failed to provide notice of its intent to sue prior to filing the complaint.” The lack of any such discussion could indicate that another shoe is poised to drop.
Barry Honig has become widely recognized of late as a financier with a questionable reputation. We have written extensively about Honig’s crucial role in several dubious enterprises, including Riot Blockchain (RIOT), and Pershing Gold (PGLC). Others have covered his relationships with Polarithttps://seekingalpha.com/article/4131031-riot-blockchain-sudden-business-pivot-suspicious-acquisitions-questionable-special-dividendyTe (COOL), Marathon Patent Group (MARA), and numerous others.
Those who have followed Honig’s career trajectory have seen that Phil Frost has been an integral part of the equation. Not only has Frost provided capital to Honig’s deals, but he has also mortgaged his reputation as a successful billionaire biotech investors as a means of providing credibility to his microcap stocks. (See examples here, here, and here.)
The Frost/Honig relationship is not new. Back in 2014, Bill Alpert of Barron’s reported on the numerous penny stock deals that Frost had participated in alongside Barry Honig and Michael Brauser, who are now all co-defendants in the SEC complaint. Per the article:
Over the past few years, these two South Florida gents (Honig and Brauser) have invested alongside Frost in a couple of dozen micro-cap companies. Scanning the list of those companies last week, I calculated that their average market cap was about $75 million. The middle of the pack (in other words, the median company) had a valuation of under $30 million.
The closeness of the relationship was apparent even then:
While Honig works out of Boca Raton, Brauser has his business in the same Biscayne Boulevard address in Miami as Opko Health and Frost’s own investment operation.
Beyond lending his reputation to this bevy of penny stock companies, Frost’s affiliated investment bank often rears its head in these deals. Investment bank Ladenburg Thalmann (LTS) – which counts Frost as its Chairman and largest holder with ~33% of its equity – regularly provides “Buy” ratings and favorable research to Frost/Honig affiliated companies.
A glance at Ladenburg’s current research coverage shows that Frost/Honig affiliated companies Chromadex (CDXC), VBI Vaccines (VBIV), IZEA (IZEA), Neovasc (NVCN), and Opko Health are all covered by the investment bank. Every single one has been issued a “Buy” rating.
So far, the most common reaction we have seen to these charges is “why”? Why would a billionaire who has built genuine biotech businesses tinker around with $5 to $10 million scores in shady penny stock deals?
Maybe he likes it? Maybe he’s good at it? Maybe he’s not as wealthy as people assume? (The Frost Science Museum in Miami, named after Phil Frost, required a $49 million bailout in 2016.)
In the end we don’t really know. Why does any really smart person do anything really stupid? At a certain point it doesn’t matter. The signs were all there and the trial evidence will speak for itself.
In addition to Frost’s longstanding affiliation with the Honig syndicate, the internal operations at Opko should have also sounded alarm bells for investors. In our piece back in November we detailed the extensively checkered regulatory and legal history of executives in BioReference Labs, Opko’s key diagnostics division. As Barron’s had reported in 2011, BioReference:
Was financed in the decade after its 1986 initial public offering by such penny-stock bankers as Paul Russo, a Mafia-associated broker, and J.T. Moran, whose firm was the model for the movie Boiler Room. They and other Bio-Reference backers ended up in jail (“There Will Be Blood,” May 23, 2011). Grodman and Bio-Reference were never implicated in any untoward activities, and he has said he never saw any wrongdoing.
At one point Grodman’s brother Joel was alleged to have posed as a salesman for BioReference in order to secure a mob-controlled union contract with $400,000 of kickbacks to mob boss Peter Gotti. Joel Grodman cooperated with prosecutors and escaped charges in the matter.
BioReference’s longstanding Chief Information Officer had a past criminal conviction and was disbarred as an attorney. He served in his role at BioReference until mid 2017, with Phil Frost’s blessing.
The fact that Frost was comfortable with the BioReference acquisition in the first place (despite its odious reputation) should have been a loud warning.
In April 2017, the Civil Division of the United States Attorney’s Office for the Southern District of New York (the “SDNY”) informed BioReference that it believes that, from 2006 to the present, BioReference had, in violation of the False Claims Act, improperly billed Medicare and TRICARE (both are federal government healthcare programs) for clinical laboratory services provided to hospital inpatient beneficiaries at certain hospitals.
The FCA probe is already in seemingly advanced stages. Now the SEC charges add another major liability to the pile.
We didn’t think the company could handle any additional liabilities in the first place. Opko’s new regulatory issues are merely another weight tied to an already sinking ship.
The company’s balance sheet is in an incredibly fragile state. As of the latest quarter, tangible equity was negative $198 million.
The business operations have provided no support. Opko recorded negative$65 million in free cash flow in the past 6 months and has consistently recorded negative free cash flow in the past several years.
Opko’s lone licensed FDA-approved drug, Varubi, recently had its intravenous formulation discontinued due to severe side effects. Intravenous treatments account for about 90% of the drug’s market, according to Opko.
Opko’s much touted 4KScore test for prostate cancer has also been a dud for reasons we have extensively documented. The test’s utilization increased a mere 10% y/y as of last quarter, coming off of a low base, despite broad efforts to advertise the test and despite vast efforts to seek reimbursement support. Per Opko’s latest 10-Q:
We do not anticipate that we will generate substantial revenue from the sale of proprietary pharmaceutical products or certain of our diagnostic products for some time and we have generated only limited revenue from…sale of the 4Kscore test. (Pg. 31)
Opko recently received a setback on its key pipeline drug as well. The FDA provided feedback on Opko’s hGh candidate drug saying that they would need to perform a year-long bioequivalence study, pushing any catalyst timeline until the end of 2019 at the earliest.
Opko’s key device offering, the Claros, has similarly stalled. We had previously extensively documented why we thought Opko’s Claros device never had any chance of achieving FDA approval. Opko indirectly acknowledged the setback on the Q2 conference call:
“(the FDA) asked for some other studies. We filed our first amendment with them and we’re now in the process of gathering the second amendment information from the field.”
We don’t see there being much left to look forward to in the way of pipeline assets.
Despite all of the above, the one thing supporting Opko’s stock, in our opinion, was Phil Frost. His insider purchases, his emergency loans, and his reputation as the billionaire “Warren Buffett of Biotech” had buoyed the company despite its cascade of repeated financial and product failures.
Now that Frost has been charged with securities fraud we think that has all changed. We do not see a bottom for Opko.
The SEC complaint is likely to have broad-reaching implications for Opko. On the financing side it will hamper Opko’s relationships with creditors and will limit other capital raising options.
Internally, it is likely to diminish morale and talent retention. (When the CEO and the company get hit for fraud people tend to brush up on their resumes.)
Notably, while the SEC is seeking to bar other defendants in the complaint from serving as officers or directors of publicly traded companies, Frost was not included on that list. This suggests that (for better or worse) he would still be permitted to run Opko or another public company regardless of the outcome of the SEC case.
All told, the uncertainty resulting from the SEC complaint is another nail in the coffin of what was otherwise a struggling, poorly capitalized, fundamentally unsound business with pre-existing regulatory overhang. We think Opko is on the fast-track to the dustbin. Price target zero.
Best of luck to all.
Disclosure: I am/we are short OPK, RIOT, PGLC, CDXC.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Additionaly I am short LTS (the dropdown for the disclosure above only allowed 4 tickers).
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