Orthopedic Development Corp. says its new spinal implant procedure can reduce or eliminate pain for many of the millions who suffer from chronic back problems.
The approach is simple and potentially lucrative. ODC’s system uses small pieces of specially shaped cadaver bone to help stabilize the spine. The Clearwater, Fla.-based company says in its promotional material that its TruFUSE procedure gives patients a middle option between physical therapy and major fusion surgery.
It even says its minimally invasive procedure can be performed on an outpatient basis, saving money and time. But former insiders tell Sharesleuth that ODC has encountered design and performance problems with TruFUSE. They add that documents given to investors in a recent stock placement overstated the number of patients who have been treated using the procedure, and may have overstated the results.
“I believe the company misled investors to raise money to market a product whose function and benefits had not been validated through clinical studies,’’ said Dan Grayson, who was in charge of TruFUSE sales from early November until early May.
Because the TruFUSE procedure relies on human body parts instead of mechanical devices, the Food and Drug Administration does not require clinical trials or regulatory approval. That means the company is responsible for ensuring that the treatment works.
As with any medical device that requires surgery, understanding the risks and monitoring the results is critical to the health and safety of the patients.
Sharesleuth examined some of the documents given to patients and investors and found contradictions in the company’s story. We thought it was important to disseminate this information so that patients considering this operation would have more information available to them, as would people considering making an investment in the company.
(Disclosure: No one at Sharesleuth, including majority member Mark Cuban, has any financial interest or business relationship with ODC or anyone mentioned in this report.)
ODC sold $8 million in preferred stock through a private placement that focused mainly on the promise and potential of TruFUSE.
The procedure was patented by Dr. David A. Petersen, a Tampa Bay area surgeon. He is ODC’s chief medical officer, as well as its biggest shareholder.
In the TruFUSE surgery, small fasteners made from cadaver bone are implanted into holes drilled into the facet joints of the vertebrae. The hope is that the graft will promote fusion between joints in problem areas, reducing or eliminating pain.
The company maintains that its procedure is less invasive than other treatment options, which translates to shorter hospital stays and faster recovery times.
ODC said in its private placement memorandum that more than 200 patients were treated using TruFUSE between March and September 2006. It said the surgeries produced “uniformly positive outcomes with no material complications.’’
Sharesleuth has seen a company document that lists all of the TruFUSE procedures by date. It shows that when ODC was claiming that more than 200 patients had received the TruFuse surgery, the internal count was no more than 83.
It also shows that when ODC claimed 500 patients, in a February supplement to the private placement memorandum, the maximum number on the list was 342.
Patient names and other identifying information were removed from the list viewed by Sharesleuth.
The discrepancy in the numbers suggests that either the company’s records are incomplete – a problem in the event of a safety alert – or that the figures in the private placement memorandum are inaccurate.
Vito Santoro, who was vice president of business operations before resigning last month, told Sharesleuth that ODC’s figures for the number of patients treated with TruFuse were more of a “best guess’’ than a hard count.
“They probably were not as accurate as they could have been,’’ Santoro said, noting that the company had trouble getting a full list of patients from doctors and distributors.
ODC markets TruFUSE through a subsidiary called minSURG Corp.
Despite ODC’s earlier statements, some patients who underwent the TruFUSE procedure have experienced problems. The list includes one person who had appeared at a presentation for potential investors as an example of a successful outcome.
Because of medical privacy laws, the identities of most of the TruFUSE recipients are off limits to Sharesleuth. However, Sharesleuth saw correspondence that discussed the above patient’s situation, identifying him by first name only.
Sharesleuth asked doctors at university medical centers about TruFUSE. Most would not speak on the record, citing unfamiliarity with the product and the surgical technique. But all said they would not consider using any new procedure on their own patients unless it had been the subject of a peer-reviewed report that demonstrated its merits.
Sharesleuth could find no such report for TruFUSE.
Dr. Michael Mac Millan, an associate professor and chief of spine surgery at the University of Florida’s College of Medicine, said an investigation of the risks and benefits should precede the marketing of almost any new product.
“I think that a clinical product that has not been evaluated under the auspices of an institutional review board of a university or hospital would fall outside the norm of good clinical practice,’’ he said.
Dr. Jurgen Harms, an internationally known spine specialist in Carlsbad, Germany, said he would require biomechanical testing results, surgical results and clinical studies.
“Without biomechanical test and clinical outcome studies, I don’t see a chance to use this product clinically,’’ he said in an e-mail response to questions from Sharesleuth.
Harms added that ODC’s approach to fusion through minimally invasive surgery was nevertheless interesting.
ODC is not a public company. It sold 4 million shares of preferred stock at $2 a share in its private placement. The stock was available only to accredited investors – those who met certain income or asset guidelines – and the minimum investment was $100,000.
ODC said in the placement memorandum that its goal was to establish TruFUSE as the treatment of choice for minimally invasive spine surgery. The company said it planned to increase awareness of the procedure among doctors, hospitals, patients and insurers, expand its marketing and sales and take the product national.
ODC cited a report that said the market for orthopedic spinal products and procedures was expected to grow from $3.65 billion in 2003 to $5.75 billion by the end of last year.
ODC’s placement memorandum said that company had 14.2 million common shares outstanding prior to the sale, including 760,000 options granted to outside directors.
Even after the sale, Petersen and Doulgeris controlled a majority of the company’s shares.
The private placement was managed by GunnAllen Financial Inc., a Tampa-based brokerage that received $800,000 in fees from the proceeds.
ODC executives declined to respond to written questions from Sharesleuth, saying through an attorney that they first wanted to know the identities of the people providing information about the company.
ODC also warned Sharesleuth not to publish information contained in the private placement memorandum, saying that it was a confidential document. However, a copy has been entered as evidence in a court case, making it a public record.
Petersen referred questions to Doulgeris, who said in an email last week that he could not respond because of the pending litigation.
GunnAllen also declined to reply to a list of questions submitted by Sharesleuth.
David H. Jarvis, GunnAllen’s general counsel, cited a policy of not commenting on litigation involving the company. He said that policy would also extend to clients of the company.
Starting in February, ODC’s officers, directors and advisory board members began receiving e-mails sent from accounts with fictitious names, raising questions about the contents of the placement memorandum. Some of the messages also went to GunnAllen.
The e-mails challenged some of the statements that ODC made in the memorandum, including the credentials and track records of its management. They also alleged that ODC was overstating the number of TruFUSE procedures and that it had no scientific basis for the claims it was making about pain relief, recovery times or failure rates.
Printed copies of the e-mails have been entered into evidence in a lawsuit filed in state court in Florida.
Those documents show that Roger L. Overby, senior vice president for investment banking at GunnAllen, responded to one of the messages from the anonymous emailer.
Overby said that GunnAllen performs “extensive due diligence” on a company and its founders and senior management before taking them on as a client. The company’s dealings with ODC, he said, were no exception.
“We believe Dave Petersen and Jim Doulgeris, co-founders and executives of the company, have done a good job of managing an early stage fast growing company in a competitive marketplace,’’ Overby wrote.
ODC responded to the e
mails by hiring a private investigator to determine their source.
ODC also asked a special committee of its board of directors to review the allegations. The company said in a notice that was posted briefly on its Web site that those directors concluded the charges were without merit.
Last month, four top managers left the company. Grayson said that he and another employee were fired and that two others resigned. The names of all four have disappeared from the contact list on the company’s Web site.
The shakeup at ODC also has inspired at least three lawsuits – one by Grayson, one by the company and one by an investor in the private placement.
PRIVATE PLACEMENT MEMORANDUM
Sharesleuth has reviewed ODC’s private placement memorandum, as well as a supplement issued a few months later. We noted that ODC did not mention any clinical trials of the TruFuse procedure, or any other broad-based, long-term study of its effectiveness.
We wondered how the company could claim, without such a study, that doctors had performed the procedure on several hundred patients without a material complication.
We also wondered what sort of review the company conducted that led it to state in the supplement in February that the failure rate for the TruFuse procedure after a reported 500 patients was “plus or minus 5 percent of cases.’’
Sharesleuth noted that the “Use of Proceeds’’ section of the placement memorandum did not contain line items for medical studies or research and development. It did, however, envision ODC buying back as much as $2.025 million in shares from existing holders.
We found that the original private placement memorandum did not contain certain information about the prior business activities of James Doulgeris, ODC’s president and chief executive, and Peter M. Sontag, chairman of the board of directors.
For example, the bankruptcy trustee for a now-closed California hospital has sued Doulgeris and his former company in connection with their management of the facility while it was trying to reorganize through Chapter 11 proceedings. The suit alleges breach of fiduciary duty and negligence and seeks repayment of more than $1 million in fees.
ODC disclosed that information in a supplement that was distributed in February, after the company received the first of the anonymous emails.
The investigation that followed those emails created a climate of suspicion at ODC, which had been a small, close-knit company, said Santoro, who had worked there since its inception in 2003.
“I think the company culture changed,” he said. “They were looking under every rock because of what was going on. It seemed like everyone became suspect. It wasn’t conducive to a career anymore.’’
ODC and minSURG also lost their vice president of sales, chief technical officer and business development manager.
Grayson was fired May 8 after raising questions internally about TruFUSE. He sued, claiming that the company breached his employment contract and fraudulently induced him to enter in that agreement.
Grayson’s complaint alleged that ODC and minSURG had no clinical data or internal study to support the claim that TruFUSE had been used on more than 200 patients between March and September 2006, with no reported problems.
His suit also said ODC and minSURG had no clinical data to support claims that TruFUSE provided “immediate pain relief” and that most patients recovered in three months of less.
Grayson’s suit added said that, up to the time of his firing, ODC had no Good Manufacturing Practice program, as required by the FDA.
Grayson, who has specialized in orthopedic medical sales for nine years, said in an interview last month that he was compelled to take his concerns public through the lawsuit because they had gone unheeded by other company executives.
“As an officer of the company, I had a fiduciary duty to investors, patients, surgeons and hospitals,’’ Grayson said. “It was my job, as the face of the company with regard to sales, to make sure that we were marketing a product that would benefit all those groups.’’
Grayson ran his own orthopedic-device distributorship before joining ODC last November, at a base salary of $200,000 a year. He said he was drawn to the company because he believed TruFUSE held substantial promise.
He still believes that product could prove beneficial to patients, provided that it is redesigned and subjected to clinical studies before it is reintroduced to the market.
Grayson said in the suit that soon after he was recruited to ODC, he became aware of graft design and graft tolerance concerns that could lead to post-operative problems for patients.
According to the suit, Doulgeris said BayCare Health System, a nine-hospital group in the Tampa Bay area, was conducting a cost and outcome study of the TruFUSE procedure, and that ODC was compiling information from surgeons elsewhere.
The BayCare study did not go forward because of BayCare’s concerns about certain elements of the program, including a potential conflict of interest on the part of one of the doctors that ODC chose to supervise it.
A brochure that ODC circulated to doctors, patients and others last year contained a question-and-answer section that also addressed the issue of clinical studies. ODC said BayCare was conducting a study.
The company said that papers on cadaver testing and engineering testing also were in the works.
“Because waiting times for publication are so long, there is no published material available specifically for TruFUSE,’’ it said in the brochure. “Five articles are being prepared by the University of South Florida biomechanical engineering department, our development partner for TruFUSE. One is complete and is awaiting publication.’’
Grayson said in his suit that he also learned that the company had no clinical study or company data to support claims about the number of procedures performed, the success rate, the average recovery time or other benefits.
Grayson said he repeatedly approached Doulgeris with concerns about the TruFUSE procedure and design, and about the potential liability the company could face by making claims that were not supported by clinical studies.
Grayson claimed in his suit that between 40 percent and 50 percent of the patients receiving the TruFUSE procedure were covered under Medicare, and that doctors were billing Medicare under an insurance code that applies to fusion treatments.
The suit suggested that if the implanted pieces of cadaver bone routinely come loose or pull out entirely and the vertebrae do not fuse, then ODC could become subject to claims of Medicare fraud.
ODC says in its marketing materials that the risks of serious complications with the TruFUSE procedure are low. It says that because the technique is minimally destructive to the vertebrae joint, there is little danger of compromising the integrity of the bone or causing nerve damage.
ODC has noted, however, that the grafts can work their way loose, or can break if subjected to excessive stress in the first few weeks after the surgery. Both of those outcomes could mean a return of pain for the patient, and could require new grafts or the removal of the grafts and treatment using a different m
ODC has filed a suit of its own in state court in Florida, claiming that Grayson and an investor named Terje Gronlie acted together to disparage the company. The suit alleged the Gronlie was behind the email campaign.
ODC said in its complaint that the messages contained numerous false statements that held the company and its executives in a false light and could hurt its sales efforts and interfere with its business relationships.
Gronlie was the biggest purchaser of stock in the private placement. ODC also alleges that he violated the terms of the placement agreement by buying stock on behalf of others who might not have met the investment criteria.
The complaint listed a third defendant, Kent Grasley, a purported freelance journalist in Hillsborough County, Fla. The filing alleged that he helped Gronlie route the emails through anonymous channels so that they could not be traced to the authors.
Sharesleuth could find no one by that name in Hillsborough County or anywhere else in the United States.
Gronlie has filed a suit of his own against the company and its executive.
COUNTING THE PROCEDURES
ODC said in its supplement to the private placement memorandum in February that more than 500 patients had been treated using the TruFUSE procedure.
Grayson told Sharesleuth that he and other employees who saw the supplement before it was distributed were concerned that the number was too high.
“It raised a red flag for us,” he said.
They decided to rewrite that section and submit it to Doulgeris. The warning was disregarded, Grayson said, and the letter went out with the original number.
ODC even referred in its second supplement to the placement memorandum to a “review” of the first 500 TruFUSE cases. It said that the review had prompted the company to increase its estimate of expected failures, to “plus or minus 5 percent of cases.’’
“With an anticipated continuing growth rate, we believe that our present clinical success rate is not reasonably sustainable and that surgeon expectations should be properly realigned,’’ it said.
Although the failure to achieve fusion through such a procedure generally would not have serious health consequences for the patient, the emotional toll could be devastating, Mac Millan said.
“It’s psychologically disastrous to be told that your treatment didn’t work and has to be redone,” he said.
THE CHIEF EXECUTIVE
None of ODC’s outside directors have expertise in the medical or medical-device fields.
Doulgeris’ biography in the placement memorandum said he had “spent 22 years of his 30 career in executive management, primarily as president, CEO and director of for-profit, non-profit, public and private companies in the hospital, ancillary provider, medical device and healthcare services sector.”
Florida corporation records show that he has been an officer or director in a dozen companies in that state since the early 1990s. He was involved in the creation of nearly all of those companies, most of which have been dissolved.
One venture that ended badly was Healthcare Resource Specialists Inc, a Tampa company that was created in 2002 to provide crisis management to troubled companies in the healthcare industry.
The company was hired in January 2003 to provide interim management at Granada Hills Community Hospital, a facility in California’s San Fernando Valley that was reorganizing in bankruptcy court.
Doulgeris became chief executive, and someone from Health Resource’s parent company, Bay Management Group LLC of Tampa, was appointed chief financial officer. According to legal filings, Doulgeris told the hospital’s board that its finances were stabilizing and that the facility could survive. But just after the Fourth of July holiday in 2003, the board learned that the management company had neglected to remit payroll taxes.
It fired Healthcare Resource and converted the hospital’s bankruptcy to a liquidation. The trustee sorting through the financial wreckage alleged that Doulgeris, Health Resource and Bay Management contributed to the collapse.
The trustee’s suit alleges that Doulgeris and the hospital’s chief financial officer acted in their own self-interest by paying $1.2 million in management fees while neglecting $1 million in payroll taxes and $5 million in bills, according to an account last year in Modern Healthcare, a trade publication. The trustee also noted that Doulgeris and the company misrepresented their experience and abilities when seeking the assignment.
Doulgeris remains a defendant in the suit, which cites breach of fiduciary duty and negligence and seeks the repayment of the fees.
Doulgeris’ biography in the placement memo makes no mention EarthFirst Technologies Inc. (OTCBB: EFTI), a company outside the healthcare industry. His name appeared as the contact person on press releases issued in 2000 by EarthFirst, which was pursuing technologies for the production of alternative fuel and the treatment and remediation of solid waste.
EarthFirst’s chairman and biggest shareholder is John D. Stanton. His biography in SEC filings describes him as a turnaround specialist for financially distressed companies.
Florida corporation filings show that Stanton also was a director of Healthcare Resource Specialists and Bay Management Group, the companies involved in the California hospital case.
BOARD OF DIRECTORS
ODC’s private placement memorandum did not mention that Sontag was formerly president of 800 Travel Systems Inc., a public company that ran an Internet and telephone travel agency. It filed for bankruptcy in March 2002 and its assets were sold.
Sontag had stepped down as chief executive in September 2001 but remained chairman of 800 Travel’s board until two days before its bankruptcy filing.
Court documents list Gary H. Baker, another current ODC director, as the trustee who oversaw the liquidation.
Sontag is a Tampa Bay-area entrepreneur whose activities have primarily focused on the travel industry. He currently is a director of World Air Holdings Inc. (Pink Sheets: WLDA), the parent company of World Airways.
Sontag also is founder and president of Fast Lane Travel Inc., which offers luxury package tours for Porsche enthusiasts that include a visit to the automaker’s factory and driving on Germany’s Autobahn.
Baker is the registered agent for Fast Lane Travel, according to Florida corporation filings.
Prior to the private placement, ODC had five directors – Doulgeris, Petersen, Sontag, Baker and Richard T. Welch.
ODC said in the placement memorandum that it paid its independent directors an annual fee of $60,000 a year, plus $2,000 for each board meeting. Directors get $6,000 for each committee membership, with the exception of the chairperson, who gets $12,000.
The company said it had accrued director’s fees of $389,000, payable partly in cash and partly in stock at $2 a share. It said it planned to use some of the money from the private placement to pay the cash portion of the fees.
Welch previously was chief financial officer of Vision Twenty One Inc., a publicly traded eye-care company based in Largo, Fla. He was a defendant in multiple shareholder lawsuits filed against the company after its stock collapsed in 19
The suits were later consolidated into a single case, whose central claim was that the company’s executives issued false and misleading statements about Vision Twenty One’s acquisition of another eye-care company, Block Vision Inc., and about its final performance afterward.
The suit alleged that Vision Twenty One touted synergies that did not exist, and failed to disclose problems with Block in a timely manner.
Vision Twenty One announced record results for the first two quarters of 1998, then posted a surprise loss in the third quarter. The company also said revenue for the earlier quarters was overstated.
It put Block up for sale, saying the divestiture would add to earnings and improve profit margins. Welch left the company in late 1999.
Vision Twenty One’s revenue declined significantly in 2000 and 2001 and the company never recovered. It settled the shareholder litigation, agreeing to pay $2.5 million to shareholders and their attorneys.
The company defaulted on its bank debt in 2002 and its assets were sold.
Welch’s biography in ODC’s private placement memorandum makes no mention of the shareholder litigation or the company’s liquidation. It simply states that Welch played a key role in Vision Twenty One’s acquisition efforts, “with over 40 acquisitions in 14 months adding $200 million in revenues.’’
Welch and Sontag both were directors of another small public company, Coast Dental Services Inc. of Tampa. The dental management company angered minority shareholders in 2003 when its majority owners – members of the founding family – announced a plan to take the company private by buying in the stock of minority shareholders.
The first proposed price was $3.25 a share. The offer later was lifted to $3.75, and then $4.50 a share, which was still very near the market price.
According to SEC filings, Coast Dental appointed Welch and Sontag as a two-person special committee of the board to analyze the self-tender offer. They were to be paid fees of $45,000 each, beyond their ordinary director pay.
Welch and Sontag’s committee rejected the first two offers as inadequate, but approved the $4.50 a share buyback price. Most of Coast Dental’s minority shareholders refused to tender their shares, and the buyback was shelved.
Coast Dental then spurned two outside bidders who were offering to buy the entire company, one at a price of $7.50 a share.
Coast Dental ultimately completed the privatization in 2005, with minority shareholders receiving $9.25 a share.
A NEW ADDITION
ODC’s private placement memorandum said the company’s board would be expanded to seven members from five. The preferred shareholders would initially elect one of the new directors, and GunnAllen would choose the other.
The preferred shareholders would get control over both of those seats in two years.
GunnAllen chose H. Jay Hill, currently executive vice president for corporate development at VillageEDOCS Inc. (OTCBB: VEDO). That company provides online data delivery, management and storage.
Its stock is thinly traded, and closed Friday at 7 cents a share.
Hill has prior ties to Overby, the GunnAllen executive who played a key role in ODC’s private placement
The New York Stock Exchange disciplined Overby in 2003. It charged that he engaged in outside business activities without the consent of the brokerages that employed him, solicited investments in outside businesses without disclosing his involvement in those businesses, and failed to disclose that involvement to his employers.
Overby consented to the charges without admitting or denying guilt and was barred by the exchange for nine months.
The NYSE’s report on the case said that, in 1996, while employed by Merrill Lynch & Co., Overby engaged in business activities with a privately held medical technology corporation without Merrill Lynch’s knowledge or approval.
In 1996 and 1999, Overby entered into consulting agreements with that company, again without the knowledge or approval of his brokerage employers. According to the report, his compensation included $290,000 in cash, plus stock options.
The NYSE said that, in 1997, while working for Prudential Securities Inc., Overby helped the medical technology company arrange a partnership agreement with another company whose shared traded on the Over-The-Counter market.
In 1999, the medical products company was acquired by its partner, and Overby became a shareholder representative within the combined business, again without the knowledge or approval of his employer.
The NYSE report did not identify the medical technology company. But the dates of the transactions it described coincide with deals between Unitron Medical Communications Inc., which was based in the Tampa Bay area, and Sabratek Corp. of Skokie, Ill.
Unitron Medical’s president at the time of the merger was H. Jay Hill.
Sabratek’s SEC filings show that Overby wound up with 34,333 Sabratek shares through the merger, while Hill had 16,451. Sabratek’s stock was trading in the vicinity of $20 a share at the time of the transaction.
Within three months, however, Sabratek’s stock had declined by nearly 90 percent. The formerly high-flying medical equipment company announced a surprise drop in earnings, failed to file its quarter report to the SEC on time and parted ways with its founder and chief executive, K. Shan Padda.
Sabratek filed for bankruptcy in December 1999. Its Unitron Medical subsidiary, which did business under the name Moon Communications, also sought Chapter 11 protection.
The SEC filed accounting fraud charges in September 2001 against Padda and three other Sabratek executives, alleging that they engaged in a scheme to overstate the company’s sales and earnings.
The SEC said the fraud occurred before the Unitron merger. The charges covered the company’s annual report for 1998 and quarterly reports through the first quarter of 1999.
All four defendants settled with the SEC without admitting or denying guilt. They agreed to pay penalties and disgorge money they had received in bonuses or other compensation.
As is often the case when Sharesleuth investigates, we find additional information that could have a material impact on the decision making of consumers or investors. We hope that this report provides valuable insight for those who will consider doing business with the companies and individuals involved.
Susan Drury provided fact-checking services for this article.