Retail gets pumped on Neptune

Prior to November, Neptune Technologies (NEPT) (NTB.TO) had been a Quebec-based producer of “krill oil”, a “neutraceutical” alternative to fish oil supplements as an Omega 3 source. The company currently still has a market cap of $150 million and typically trades over 200,000 shares per day and has liquid options in December, January and February.

On November 8th, a massive explosion ripped through Neptune’s only production facility, killing three people and sending 19 survivors to the hospital, some with critical injuries. In all, this amounts to 20% of Neptune’s workforce. The pictures and videosshow that it was a miracle that anyone was able to survive this horrific industrial disaster. All that remained of the factory was a smoldering pile of twisted metal I beams and pulverized concrete.

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Heightened risks at Baidu

Over the past few years, I have been a consistent bull on (BIDU), which has served me quite well on a number of occasions. However, as a number of new risks have emerged at the worst possible time, I am now turning very bearish on the share price going forward. Over the medium term (6 months to 1 year), I am moderately bearish, but in the near term, I am significantly more bearish and see the share price potentially breaking through the $70.00 level.

As for the positives, Baidu continues to occupy a dominant place in the Chinese internet space, and at any price below $100, it appears to be exceedingly cheap for a number of good reasons. The company has a formidable ROI of over 40% and net marginswhich are still roughly 50%. The only criticisms that analysts can find with Baidu are that revenue is not growing at the scotching clip that it had in the past as well as the potential for further slowdowns as Qihoo 360 (QIHU) continues to make progress in the market for online search at a surprisingly rapid pace.

However, there are several macro and micro risks to the share price which could send the share price sharply lower, and at a minimum these concerns will almost certainly put a cap on the share price at current levels. In the vast majority of articles, authors speak extensively about all of the strong fundamentals that can be found in Baidu, and I agree with their sentiments in this area entirely. The problem is that in overly focusing on the easy to analyze (and positive) quantitative elements, these authors make little to no mention of the harder to analyze (and negative) qualitative risks that clearly dominate the equation in a massive way. In short, they are completely ignoring the factors that are by far the most important in determining where Baidu will trade in the near future. Recent examples include:

The Best Stock for 2013

Is It Time for You to Buy Baidu? (Hint: Yes.)

The key concerns with Baidu are as follows:

  • Concerns over SEC / audit risk
  • Concerns over the VIE structure
  • Concerns over an expected acquisition
  • Concerns over growing Qihoo threat
  • Concerns over significant tax-loss selling in December

Each of these concerns would not be nearly as significant if they occurred in isolation. The problem for Baidu is that all of these problems are coming to a head at the same time. And with the stock now brushing on multi-year lows, the temptation to harvest significant tax losses to offset taxable gains on better performing stocks will be very strong during the next 2 weeks.

The SEC and VIE issues obviously apply very broadly to many Chinese stocks. However, the last 3 issues are very specific to Baidu. Given the rise in Baidu’s share price over the past few days, it appears that many investors are demonstrating very short memories with regards to concerns in the past and are likely being distracted by micro news which could easily be overshadowed. Each of these concerns is discussed below.

Concerns over SEC / audit risk

The SEC and VIE risks are equally applicable to all of the Chinese internet stocks, including Sina (SINA), (YOKU), RenRen (RENN) and Qihoo 360 . Selected other non-internet stocks can also be included in this group such as New Oriental Education (EDU). With the SEC issue and the VIE issue, investors are again showing how quickly they forget about significant problems as soon as some small, positive piece of new information arrives. In both cases, the SEC and VIE issues have not dissipated in any way.

News of the SEC’s interest in inspecting the audit files of the China-based arms of auditors hit during the week of November 26th and there was minimal reaction. But then the SEC released its administrative order against Ernst & Young, KPMG, Deloitte, PWC and BDO on December 3rd. This group of “Big 4” plus one audit the majority of Chinese stocks that trade in the US. Baidu had already traded as low as $91 in the previous week, which many viewed as a compelling buy opportunity. The stock rose as high as $99, but when the SEC’s order came out, Baidu quickly dropped to a multi-year low of $85.96.

Some investors have come to the conclusion that if Baidu does not have any accounting problems itself, then there should be little risk of a closer eventual look by the SEC into the audit papers of its auditor E&Y. This is not the case.

As most China focused investors have become aware, there is a significant contagion problem when investing in Chinese stocks. In 2011, a large number of smaller cap Chinese stocks failed their audits and were delisted. This fact alone took down many other stocks which had no audit issues of their own.

More recently, in July when New Oriental announced that the SEC was inquiring into details of its VIE structure, all other VIE stocks took an immediate and substantial dive. At the time, BIDU had been trading at around $110 before suddenly dipping below $100 for the first time in years.

The point is that even if Baidu has no accounting issues of its own, if a closer look by the SEC reveals any problems at anyother US listed Chinese internet company, then we can be sure that Baidu’s share price will be significantly affected.

Of equal concern is the fact that the stalemate between auditors and the SEC is in no way resolved and looks like it will escalate into a significant confrontation.

In response to the SEC administrative order, PWC issued the following statement:

Today’s action by the U.S. Securities and Exchange Commission is the result of conflicting laws between the U.S. and China. The fact that the action is being taken collectively against all of the four largest audit firms and one other firm demonstrates that this is a profession-wide issue, not unique to one firm. For its part, PwC China has cooperated with the SEC at every opportunity.

However, PwC China will, and must, comply with its legal obligations under China law. This action involves an issue that needs to be resolved between the US and China regulators as it impacts all audit firms in China serving clients who are registered with the SEC. PwC China hopes for continuing dialogue between those two parties to resolve the matter.

That statement was included in an article entitled “Chinese ADRs, Accounting Fraud, and Delisting Risk,” which is well worth reading for anyone who invests in the China space.

So clearly resolution of this issue is going nowhere fast. However, in the US capital markets, the auditors are not on equal footing with the SEC. The SEC makes the rules and the auditors are supposed to play by them. The clear risk here is that the SEC may choose to implement a temporary solution to the problem as it waits for cooperation from the Chinese government which may never come. Investors will have no idea what this temporary solution may be or when it will come until the SEC announces it, and the effect will once again be significantly detrimental to Baidu and other US listed Chinese stocks.

Concerns over the VIE structure

The problems associated with VIE structures have been discussedoff and on for a few years, but received the most attention back in July when New Oriental revealed that the SEC was looking into the details of its VIE structure. It continues to surprise me how many investors, including large institutional fund managers, have no idea what the implications are when owning a VIE stock.

VIE stands for “variable interest entity” and it means that the shareholders of the company have no claim on the underlying assets of the company, which is entirely contrary to the very concept of owning stock in the first place. The reason for this odd structure is that certain industries in China (such as internet and education) are considered to be protected and sensitive industries and foreigners are not allowed to own them. To work around this, US bankers developed a structure whereby investors own shares in an offshore (usually Cayman) company whose sole asset is a contract with the underlying company which gives them a contractual right to the earnings of the company. The ability to enforce this contract has not really been tested and remains unclear.

What this means for investors is that if anything goes wrong and the company spirals downward in value, there is no real floor to the stock because no white the likes of Warren Buffett will come in and acquire the entire company to gain access to its assets. Buying the whole company is useless because what you would really be buying is just the shares in a Cayman Islands company whose sole asset is an unenforceable contract.

As investors woke up to this reality in July, Baidu fell below $100 for the first time in years. Yet within a few months the stock rose to as high as $135. Investors simply forgot about the fact that they owned nothing due to impressive earnings from Baidu in August. It is quite literally the case that Baidu could discover oil beneath their headquarters in Beijing and it would deliver no legal value to Baidu shareholders, so it is notably odd that better than expected earnings would cause some investors to temporarily forget their previous concerns over the VIE structure. That doesn’t mean Baidu should be sitting at zero, it just means that the valuation should be discounted accordingly. At a price of $135, there was clearly no discounting taking place, nor is there at a price of $95.

Concerns over an expected acquisition

In August, Baidu raised $1.5 billion in a bond deal directed at US investors. Baidu already has over $3 billion of cash on its books and that cash balance has been growing at a rate of around $500 million per quarter. Clearly, Baidu doesn’t need money for continuing operations so most investors are expecting anacquisition. The most obvious target would be a company which can help Baidu ward off the invasion by Qihoo into the internet search space.

A good acquisition could help to allay investors’ concerns over Baidu’s slowing revenue growth due to Qihoo. However, any acquisition that is perceived as being only marginally beneficial or even over payment for a better acquisition could also hit the shares hard.

Baidu has the technical and financial resources to embark on a variety of business improving projects, so the perception that Baidu must go out of house to rejuvenate its business has raised concerns over management’s ability to identify and implement solutions on its own.

In addition, large internet companies have a less than impressive track record of integrating their target companies as planned and overpayment for acquisitions is very common.

This issue would clearly be less of a concern absent the other issues, but with Baidu facing a number of headwinds from multiple directions, a less than optimal acquisition will be very poorly received by investors.

Concerns over growing Qihoo threat

In April, I had voiced a number of concerns regarding Qihoo 360 and I felt that there was even some risk that Qihoo might face problems in its upcoming audit by Deloitte. Three weeks later, Qihoo passed its audit without issue and it was back to business as usual. In June I sat down with Qihoo CEO Zhou Hong Yi in his office in Beijing for a 2 hour chat. Our chat was extremely interesting, and contrary to his public persona as the “mad dog” of the Chinese internet, he was exceedingly personable. We spent very little time discussing past issues as Mr. Zhou was primarily focused on telling me about Qihoo’s future. I had been asking a number of questions about mobile applications, which is where I expected him to tell me that Qihoo’s future revenue growth was going to come from. Instead, all Mr. Zhou wanted to talk about was Qihoo’s future in search. At the time, I largely dismissed his ambitions in this area due to my perception that Baidu’s dominance was unassailable. He did talk a very good game though and I left his office with the distinct impression that Mr. Zhou was an individual who can clearly “talk the talk.”

Just 8 week later, Mr. Zhou demonstrated that he can also “walk the walk” when Qihoo announced that it had already captured 5-10% of the search market, which we all know had to come at the direct expense of Baidu. Baidu’s shares took an immediate tumble in August, and then tumbled again in November when Qihoo announced even more progress and search and a new initiative to launch a music service in competition with Baidu.

A year ago Qihoo was notably overvalued. Now, the share price has risen slightly but Qihoo has quickly grown into its valuation. Qihoo now has nearly $400 million in cash and is profitable in a meaningful way. With a presence built into the computers of a few hundred million Chinese internet users, Qihoo has a notable advantage over Baidu in aggregating information from users as well as their preferences for a wide variety of applications.

Baidu is still in the dominant position by a very wide margin when it comes to search. It is not the level of threat from Qihoo that is concerning, but instead it is the very rapid rate with which Qihoo is making progress that is concerning. In addition, Qihoo has already demonstrated that it is willing to take the fight to Baidu in multiple arenas, including search, mobile and music.

So far these inroads have been large relative to Qihoo’s history, but small relative to Baidu’s dominance. I am currently expecting that Qihoo will hit a major tipping point in tacking Baidu either in Q4 2012 or in Q1 2013. As soon as Qihoo hits the 20% mark, concern among Baidu shareholders will become far more noticeable.

China’s internet space is certainly big enough for two large players and at the current share prices both Baidu and Qihoo would be considered a strong buy. However, both of these stocks share the same risk factors with respect to the SEC / audit issue and the VIE issue. As a result, at a minimum, the share prices are likely to see their movements capped in the near term. The problem for Baidu is that it is falling from a position of strength while Qihoo is rising from (formerly) of no position at all.

Concerns over significant tax-loss selling in December

Once again, comparing Baidu to Qihoo is instructive. Qihoo is currently trading at around $25.00, which is near its 52-week high of $28.16, reached just last week. Qihoo is up from a 2012 low of $13.95 which means that anyone who bought Qihoo during the course of 2012 is likely up on their investment and has no tax motivation for selling.

By contrast, Baidu has a very ugly chart which is likely to incentivize substantial tax loss selling in December. Baidu began the year at $125 and reached a high of over $150 in April. Prior to November, the stock only briefly traded below $100 following the New Oriental fallout. However, it has now been over 1 month since Baidu closed above $100 and it looks unlikely to be able to break this key barrier in the near future. As a result, and unlike Qihoo, virtually 100% of investors who bought into Baidu before November are now sitting on losses of as much as 30-40%. The only reason to not sell Baidu in December for the tax benefit would be if Baidu was expected to soar in Q1 2013. Given the number of other concerns and the magnitude of these concerns this is highly unlikely, so tax selling makes the most sense for investors who are underwater on Baidu.


After seeing the stock trade north of $130 for much of its recent life, predicting a stock price at or below $70 may seem aggressive. However, looking at the fate of Sina shows that this is an entirely realistic scenario. For a long time, Sina was an internet darling in China. Sina peaked out at $140 in 2011 before hitting a rough patch and quickly trading down to around $70-80 per share. At that time Sina’s twitter-like Weibo service was just hitting a positive tipping point, as were the prospects for its profitability. Unlike Baidu, Sina has struggled with profitability, although revenues continue to grow sharply each quarter. Despite this, Sina continued downward to below $50 by the end of 2012 before rebounding to a 2012 high of $80 again. Last week Sina looked set to now break below the $40 range, and only a reported relaxing of government controls on Weibo has pushed it up this week. Over the past few days Baidu has risen on the back of the rise in Sina simply due to the fact that China internet stocks trade as a sector and not on the back of any significant positive developments for Baidu. In fact, both Sina and Baidu share the same big picture risks. However, it is simply the case that Sina has already fallen so much further than Baidu that some bottom fishing may be perceived as understandable. In fact, both stocks still face substantial downside risk as well a strong headwinds against meaningful appreciation before year end.

Personally, I have developed a bit of a negative bias against Baidu following the work I did while looking into Qihoo some months back. I was trying to find a comparison point to evaluate Qihoo’s advertising revenues on its web portal The most obvious point of comparison would be Baidu’s hao123.comwhich is nearly identical in all respects. Despite a widespreadrumor that Baidu’s hao123 would account for over 20% of Baidu’s profit, Baidu consistently refused to break out this segment of its business and I saw no reason to not simply disclose it. I made numerous attempts to speak with Baidu’s CFO, all of which were rebuffed for the simple reason that she was “too busy” to speak with a shareholder who writes extensively on Chinese stocks and who has been consistently positive on Baidu. I have had in person meetings with senior management at over 100 public Chinese companies, yet with Baidu by the end I found myself begging for just 10 minutes of time on the phone and I couldn’t even get that. I was able to speak with Baidu’s investor relations department, but as is often the case with many companies, IR’s answers typically consisted of “I don’t know” or “we don’t disclose that,” making for several very unproductive conversations. Even over the past year when my views on most Chinese stocks have been negative and short focused, I have still been able to get meetings with senior management at every company in which I have had an interest, with the exception of only Baidu. Also, ultimately I was able to go through various other means and sources to find out that the 20% rumor was dead wrong and that hao123 contributes well under 5% to Baidu’s bottom line.

I found this experience with Baidu to be particularly troubling in comparison to my experience with Qihoo. With Qihoo I had been a constant skeptic and critic for nearly a year and I had often been short the stock and been vocal about my negative views. Yet I was able to have more than 5 conversations with Qihoo’s CFO Alex Xu who even gave me his cell phone number and took my calls on the weekend. If he bore any grudge against my negative views, it certainly was not evident from my discussion with him and I felt I was treated the same as would be any long shareholder. One of my articles on Qihoo received considerable attention before their audit, enough for them to issue a written response. Yet a few weeks later I was able to sit down with Qihoo CEO Zhou Hong Yi in his office in Beijing and spend 2 hours talking about Qihoo’s future. For reference, Zhou Hong Yi is the CEO of a $3 billion NYSE listed company and he is roughly a billionaire himself, so I had not expected to get this much of his time, especially on short notice.

Initially, I had concluded that Baidu was simply guilty of some (perhaps semi-deserved) arrogance due to their dominant position in the China internet space and the size of their company, which was as the time over $40 billion in market cap.

That might very well be the case, however as I discussed my disappointment in Baidu with a number of institutional investors in Beijing, I found that the response was quite consistent regardless of who I spoke to. Investors describe Baidu as a “black box” because the company achieves spectacular results without always breaking out the key information which would better explain those results. This is something that always makes me uncomfortable and I have gotten the impression that many other investors have not been successful in having a dialogue with Baidu either. As with all investments, investors have a choice with Baidu as to whether to hit “buy” or “sell” on any given day, and as we can see from the stock price, more investors are hitting sell than buy, pushing the stock to multi year lows. Regardless of whether it is corporate arrogance or a resistance to disclose information, Baidu is now no longer in a position to be practicing either given that its share price has fallen precipitously and it is under attack by a competitor.

Based on all of these points, I am now short Baidu. The short thesis is pretty easy for Baidu, even given its omnipresence in the Chinese internet world, its dominance in search and its strong fundamentals. The short thesis is simply that there are many factors which could send Baidu sharply lower, but basically none which could send it sharply higher. The only risk in the near term is that the stock does nothing and stays flat or only declines by a moderate 5-10%.

The SEC risk, the VIE concerns and the uncertainties over Baidu’s ability to sustain its wide lead in the space may or may not cause a more meaningful drop in the stock in the next 2 weeks. But in any event, these concerns are almost certain to prevent a substantial rise in the stock. Over the longer term, Baidu’s much suspected acquisition will be very important. If they get it right, it could help the stock to some extent. But if they get it even slightly wrong or overpay for it, then the share price will certainly suffer.

The only real catalyst for Baidu to rise would obviously be some clarity out of the SEC regarding its issues with audits and VIE structures. However given that this process involves cooperation between the SEC, the auditors and the Chinese government, any progress will undoubtedly take a minimum of a few months. By that time, we start entering audit season for 20F filers, which comprises all of the Chinese internet names. Many investors (myself included) simply refuse to hold any Chinese stocks during audit season. This is simply due to the contagion problem which has shown that even if any given company has no accounting issues itself, a problem in any other related company will have a significant impact on the share prices of their entire peer group.

The point of this last observation is simply that Baidu shares have the risk of significant downside in the near term, but no real catalyst for upside until the audit season ends in May.

The author can be reached at

CBAK is insolvent

Normally I try to shy away from very low priced stocks, however in the case of China BAK Battery (CBAK), it is a company which I have been quite familiar with for years while living in China. I am very well informed about the company’s complete insolvency as well as the unusual rise in its share price. Due to its insolvency, China Bak’s worth is in fact negative, far below zero. So it seems quite likely that the share price will soon react appropriately to this fact in the near term.

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A troubling visit to Cleantech

Cleantech Solutions (CLNT) is a tiny $12.0 million market cap company which describes its business as the manufacture of forged and fabricated products for end use primarily by manufacturers of windmills in China. The share price has nearly doubled in just the past week.

The share price history of Cleantech is very confusing to some people given that it has now done two reverse stock splits, first doing a 1:3 reverse split, then subsequently doing a 1:10 reverse split. As a result, although the share price appears to have traded as high as $144.00 in the past, the reality is that this stock has never traded above a real price of roughly $8.00 in its entire history. When looking back at the share price history, it is important to note that a past price of $30.00 really means that the stock was trading for just $1.00 at that time.

Only briefly did it spike above $5.00 back in 2008, but since then it has traded almost entirely at $5.00 or below. Again, a historical price graph may give the reader a different impression due to the reverse splits but this stock has simply never traded in the double digits, much less the triple digits. Ever.

In early 2011 this was once again (following a reverse split) up to $4.50 per share, but was steadily trending down. It ultimatelybottomed out once again at just 25 cents earlier in 2012. The reverse split conducted in March of 2012 caused the stock price to be once again restated as $2.50 and it had stayed between $2.50 and $2.80 until just a few days ago.

The stock jumped substantially on the date of Cleantech’s earnings release due to stronger than expected reported sales as noted in its unaudited financials. The obvious weak point,however, was that the company is now down to just $960,000 in cash, which is only enough for it to survive at all for about two more months given its rate of cash consumption.

Last year, I had the interesting opportunity of visiting Cleantech Solutions in Wuxi, Jiangsu Province, China. This was only a few hours by plane from Beijing, where I live in China, so it was certainly not an inconvenient trip to make. I had been contacted by a shareholder who was a firm believer in the company and had felt that at a price of $3-4 it was deeply undervalued. It should be noted that my visit was prior to the company’s 1:10 reverse split, so in today’s terms, that would have been viewed as a price of $30-40.

Without the reverse split, the nominal price for Cleantech today would obviously be at 1/10th of where it is today, so $0.45 relative to the $3-4 at the time of my visit. As a result, based on my past history with the company and the stock, I view Cleantech currently as a $0.45 stock not a $4.57 stock. Basically, I continue to simply look at the overall value of the company rather than just the nominal stock price.

I showed up at Cleantech on a Tuesday, prepared for a full day tour of the facilities and interview with management. Management had been informed about my visit some weeks before and I was told that they planned on putting on quite a show of how their business was booming. However, the entire tour of the facilities took less than 30 minutes because the operations were conducted in a single, small open air warehouse.

The part that was intended to be so visually impressive was the ESR (“electro-slag re-melted”) production facilities and this was also said to be the key driver of CLNT’s huge future revenue potential. However, apparently the ESR line takes time to heat up and start production, and it wasn’t running at all on the day I visited.

Instead what I saw was quite literally fewer than 10 employees (in total) engaged in very low-end metal stamping of forged rings which are used in windmills.

Including all members of management who were present, Cleantech had less than 15 people on site on the day of my visit, which struck me as notable given that its SEC filings had stated it employed several hundred people. I distinctly wondered, “where are all of the employees?”

Ordinarily, I would try to be more understanding of the variation between daily production output in a factory. However, at the time, Cleantech had made it known that it was operating at absolute full capacity, meaning that production should have been going full bore from dawn to dusk every single day of the year. In addition, I had been promised that I would be shown the state of the company at its absolute best.

Rather than give up entirely due to my disappointment, I decided to tell management that this was clearly far from impressive and I came back the next day. When I came back the next day, the situation was absolutely identical with no ESR line running and again just a handful of employees engaged mostly in moving (rather than production of) a small number of large low-end metal rings.

For some reason, management couldn’t really give me much of an explanation for why these two particular days were so empty and devoid of any activity, and it was notable that they did not in any way suggest that other days were in any way more active. I was given a very clear understanding that I was seeing a very normal day of operations at Cleantech. Management also didn’t have any answer when I asked about the whereabouts of the several hundred other employees who should be present. Instead, management just encouraged me about the company’s very strong prospects going forward and assured me that future profits were going to be exceptionally strong.

Another development I was told was very positive was the then-recent appointment of Cleantech’s new CFO, Fernando Liu. But as it turns out, I was told that despite being CFO, Mr. Liu wasn’t even living in China. They did however let me know that Mr. Liu had visited Cleantech on multiple occasions. In any event, it was unfortunate that I did not get the chance to ask him directly about my concerns regarding lack of production or the lack of any employees at the company.

As it turns out, Mr. Liu ended up resigning as CFO and as soon as Cleantech passed its annual audit (which claimed a lofty $55 million in revenues), he sold all of his shares in CLNT at prices as low as $1.58. He made these transactions quickly in a period of just a few weeks, even though business seemed to be booming (according to the SEC filings) and even though the share price was now touching all-time lows for its entire history as a company.

I took the view that if this was the most compelling display of activity and commitment that management could muster for a 2-day visit of a potential investor, then there was no way I could possibly invest in this company. I left disgruntled at having wasted 2 days of my time to view a company that clearly was engaged in no business whatsoever.

It turns out that I was correct in my assumption. Over the course of time, Cleantech dwindled down from that share price of $3-4 to just 25 cents during early 2012. At this time the company did the 1:10 reverse split, taking the share price back up to a nominal level of $2.50. Even following the recent run-up in the stock over the past few days, had I bought in at $3.00 at the time of my visit, I would now be selling at the equivalent of just $0.45 due to the impact of the reverse split, i.e. already a decline of 85% even at the recently higher price.

From the start, one major issue for me was Cleantech’s choice of auditor, Sherb & Co. This was all the more concerning given that Cleantech has had to disclose that “management identified significant deficiencies” in internal controls for preventing fraud, and that these weaknesses have been present and unchanged several years without any correction to them.

During my visit to Cleantech, I had been assured that the company would be upgrading to a Big 4 auditor “imminently,” yet this still hasn’t happened, and there is no sign that it is in the works going forward.

Sherb has been the auditor of record for some of the most notorious Chinese reverse merger frauds which were later exposed and delisted by the SEC and the stock exchanges. (Links to delisting notices are included below).

There are two important points worth noting:

First, with the exception of Cleantech (and only Cleantech), all of Sherb’s Chinese audit clients now trade for just pennies even though many of them were one-time high fliers trading at well over $10.00. As we can see, were it not for the reverse split, Cleantech would also be trading at just $0.45 rather than at $4.57.

Second, it is very odd that many of these companies continue to put out extremely positive press releases and filings. Quite surprisingly, the positive stream of bullish new continues even after their delisting. In many cases, the companies which are only $5-15 million in market cap report cash balances in excess of $50 million. The only explanation for such a discrepancy is that the market simply does not believe that the cash is really there. In fact, if the cash were actually there, management could simply use a small portion of the cash balance to buy up the entire company and immediately pocket tens of millions of dollars for themselves. But notably, this just doesn’t seem to happen with any of these companies.

Chinese audit clients of Sherb & Co.

Ticker Company Price Auditor Status
CLNT Cleantech Solutions $4.57 Sherb & Co. Still trading and listed !
CEAI China Education $0.45 Sherb & Co. Delisted due to fraud
CHNG China Natural Gas $0.60 Sherb & Co. Delisted due to fraud
CHLO China Logistics Group $0.01 Sherb & Co. No audit committee
QING Qingdao Footwear $0.01 Sherb & Co. Mgmt resignation due to fraud
CDII Cd Intl $0.12 Sherb & Co. Delisted due to fraud
CPHB China Pharmahub No longer trading Sherb & Co. Ceased all filings
SDTC Sentaida Tire Co $0.01 Sherb & Co. Never listed past OTC
SUWN Sunwin Stevia $0.20 Sherb & Co. Never listed past OTC
SHZ Shen Zhou Mining $0.26 Sherb & Co. Down 99% from $10.00 in 2011
OINK Tianli Agritech $0.83 Sherb & Co. Down 90% from $8.00 in 2011
FRXT Fuer International Inc. No longer trading Sherb & Co. Never listed past OTC

In the case of China Education Alliance (CEAI.PK), Sherb had even put out a statement noting that Sherb had “performed enhanced procedures on the cash balance,” causing the shares to rocket back up to $3.50 before the company was ultimately delisted. The huge run-up in the stock followed by a subsequent delisting left many investors wondering what exactly was meant by the phrase “enhanced procedures” which Sherb used to verify the cash balance.

At the time, CEAI had just reported that it had generated over $35 million in revenues in just the previous 9 months, so even at $3.50, the stock looked very cheap as long as the audited results were in fact real. However I had also just visited CEAI some weeks before and toured all of their facilities in Harbin for an entire week. What I found was that in all of their facilities combined, CEAI had no more than 300 students in total. The obvious conclusion was that there was no way that CEAI could be generating even just 1/10th of the revenues that it was reporting to the SEC.

Not surprisingly, China Education Alliance was subsequently delisted to the pink sheets due to findings of fraud even after the assurances provided by Sherb. However, just last week the company yet again announced stellar results and reported a cash balance of over $65 million, in comparison to the $4 million market cap for the entire company. The stock still trades, but only a few thousand dollars per day and the price is just $0.45 on the pink sheets.

Similar to CEAI, Cleantech has spent most of 2012 trading just $30-50k per day, until days such as yesterday where it suddenly traded over $4 million in a single day. In fact, despite the fact that there are only 2.6 million shares outstanding for the entire company, nearly 1 million traded on just Tuesday alone.


I have been living, working and traveling in China for over 20 years. I speak Mandarin quite well, and I also spent many years as an investment banker on Wall St. I have visited over 100 Chinese companies during just the past few years and I have seen some very good companies and some companies which are engaged in egregious fraud.

In this case, I realize that I have the distinct advantage that I actually had the opportunity to visit Cleantech in person and was shown the best side that the company had to offer. I am not simply assuming that the opportunity looks too good to be true, instead I have confirmed it in person.

Even when business was supposed to be booming at its peak, Cleantech operations consisted of a single open air warehouse with less than a dozen employees engaged in making a small number of simple, low-end metal rings.

But even for those who haven’t had the chance to visit Cleantech in person, the continued use of an auditor with a uniquely troubling history of signing off on fraudulent financials as well as the continued lack of internal controls at Cleantech should be enough cause for any sensible investor to seriously question the publicly released numbers.

Now that Cleantech is back above $4.50, how low can this stock go once again? Each time the stock falls back below $0.50, the company simply conducts another reverse split to get the cosmetic price up high enough to keep it from looking like yet another penny stock. And each time the stock briefly rallies back to a notional level of $3-5. Afterwards, it quickly drops back down to $0.50 again, which is where I expect it will find itself within a very short period of time.

Following the huge run-up on Tuesday, I shorted Cleantech in the aftermarket at a price of $4.68. If the stock rises more, I will gladly short more. And in fact if the stock falls, I will also be shorting more.

The author can be reached at

Hi-Tech Pharmacal Set to Drop 60%

Hi-tech Pharmacal (HITK) is a $450 million market cap manufacturer of prescription and OTC drugs. The company came public in 1992. It was founded by Bernard Seltzer, and is now currently run by his sons, David Seltzer and the very colorful and entrepreneurial Reuben Seltzer. The two now fill the roles of CEO, Chairman of the Board, President, Vice Chairman and Director.

On the surface, Hi-tech has many of the hallmarks of a very safe investment, including:

  • a strong cash balance with nearly $6 per share vs. $33.32 share price
  • an apparently low PE ratio of 11x (trailing 12 mos)
  • a presence in a stable, counter cyclical industry
  • a high level of management ownership
  • over 50 different drug products currently in the portfolio

However, a closer look reveals that Hi-tech Pharmacal is a company beset by significant near term problems from all directions. A notable lack of sell side analyst coverage has meant that the significance of these problems has not been widely disseminated or understood by investors.Only one major sell side brokerage covers the stock (Bank of America), which reiterated an “underperform” rating when the stock was at $31.00, however their coverage has been infrequent.

As soon as next week (when earnings are announced before market open on Thursday), Hi-Tech shares are likely to begin a rapid descent of at least 20-30% and could subsequently stabilize at a level that is as much as 50-60% below the current share price of $33.32.

Continue reading…

The Bears Weigh in on Ziopharm


On October 23rd, 2012, Seeking Alpha author “Wall Street Teacher” published this article entitled “The Bears Weigh in on Ziopharm”. The article was removed due to the numerous factual inaccuracies stated.  Investors who have relied upon this analysis may want to re-read it and verify it, so a link to a copy of his story is below.  Note:  As described below, Wall Street Teacher appears to have an undisclosed relationship with ZIOP.

Wall Street Teacher does not reveal his real name, but his publishing history is revealing.

Investors have relied upon his analysis for years, yet it appears that he has a unique relationship with ZIOP that is not readily apparent or even disclosed.

He has posted bullish analysis over 100 times, discussing ZIOP on Seeking Alpha over a 4 year time frame.  This includes 8 published articles, 24 instablog posts (not published) and extensive brief but bullish comments.

During that time, he has only ever written just a few short paragraphs on just a single other company. As someone who claims broad and diverse financial expertise and interests, this is notably odd.

In effect, Wall Street Teacher has written on ZIOP and only ZIOP for 4 years without writing on any other companies.  

The day after it was published, Seeking Alpha took the article down due to very material and blatant inaccuracies which were contained in the article.    For those who took comfort from his rebuttal of my article, they should take a very close look at what he said vs. what the actual facts are.  And more importantly, given his 4 year exclusive publishing history with ZIOP and only ZIOP, readers should start to ask themselves:

1. Who is Wall Street Teacher ?

2. What is his real and undisclosed relationship with ZIOP ?


Although his story was pulled from Seeking Alpha, it is not my goal to bury it.  In fact, I WANT readers to read it because it highlights my concerns about inaccurate and promotional statements regarding ZIOP, and shows that his relationship with ZIOP was undisclosed.

I have also posted my original article here as well, because I also want readers to re-read it and verify the facts, all of which are 100% true and are supported by links to source documentation.


The Bears Weigh In On Ziopharm – Seeking Alpha


ZIOP: Undisclosed FDA warning letter

Ziop: Undisclosed FDA Warning Letter, Palifosfamide Instability And More

[Authors note: This article appeared online on Friday, October 19th, 2012 in a different location. A few hours later the story was taken down from that website without any notice or explanation to the author. The website in question raised precisely zero questions or issues regarding the accuracy of the piece.  The author apologizes for any inconvenience. Throughout this article, the author has emphasized that upon notification of any confirmed factual errors from any reader, he will quickly correct any such error and explain any discrepancy.]


On September 24th, shares of Peregrine Pharmaceutical (PPHM) plunged from $5.37 to as low as $0.80 (85%) in a single day when management announced that there were major discrepancies in the Phase II data for its cancer treatment of Small Cell Lung Cancer. Even though Peregrine appears to have been prompt in disclosing these errors upon discovery by management, the usual crowd of law firms were quick to compete for filing the fastest and biggest lawsuit against the company.

By contrast, the serious problems at Ziopharm Oncology (ZIOP) have never been disclosed to investors and the problems at Ziopharm appear to be dramatically worse than those at PPHM.

Over the past few months I have spent hundreds of hours conducting extensive due diligence on Ziopharm and I have spoken with over 100 knowledgeable experts is various scientific and medial fields as well as senior FDA officials and biotech executives.

However even though these many individuals were extremely helpful, the reality is that all of my findings could have been assembled by any investor who conducted a thorough review of publicly available online documents such as those provided by the SEC, the FDA and Ziopharm itself.

Please note, today I called CEO Jonathan Lewis on his cell phone to discuss the issues raised in this article. He declined to answer or respond to any questions and suggested I direct any questions regarding Ziopharm to Investor Relations.


During 2009, Dr. Jonathan Lewis served in dual roles for Ziopharm as both CEO and CMO simultaneously, despite the fact that the dual role creates an obvious appearance of conflict of interest. This dual role and conflict of interest should be kept closely in mind when considering Ziopharm’s activities during 2009 and 2010.

In August 2009, while Lewis was serving as CEO/CMO, an FDA audit uncovered very serious “deficiencies” in the conduct of the lead investigator (Dr. Sant Chawla, SarcomaOncologyCenter, Santa Monica, CA) for the Phase II trials of Palifosfamide. A scathing FDA warning letter was subsequently issued which specifically questioned the “reliability and integrity of the data” in the Phase II trials.

Upon the FDA’s completion of the audit, the FDA issued a Form 483 to document the specific “deficiencies” found. In particular, the FDA specifically challenged “the reliability and integrity of the data” in the Phase II trials for Palifosfamide. However, because the words “Ziopharm” and “Palifosfamide” were redacted on the FDA’s website, Ziopharm has never disclosed this warning letter to investors. Dr. Chawla’s office has now confirmed all of the details in thewarning letter, noting that Ziopharm was notified in writing by the FDA at every stage. FDA officials also confirmed that warning letters and Forms 483 regarding clinical trial investigators are always shared with the sponsor in writing.

It seems almost inconceivable that such a blatant “smoking gun” document could have existed on an FDA website for nearly three years without anyone figuring it out. As a result, I exercised excessive scrutiny and skepticism before coming to any conclusion.

Because of the redaction, FOUR important elements needed to be verified beyond any conceivable shred of doubt. Nothing less than 100% certainty on ALL of these points would be acceptable. The FOUR elements are:

1. Was this letter actually issued in connection to Palifosfamide and Ziopharm ?

2. Had the letter ever been publicly disclosed in even a single place, however obscure, at any time whatsoever by Ziopharm ?

3. Was Ziopharm informed about the audit, the Form 483 and the FDA warning letter ? Is there any possible way that Ziopharm did not know about these issues ?

4. Is there any conceivable way that the FDA’s comments in this letter could be perceived by any reasonable person to not be material, and therefore not require disclosure ?

The first thing I did was to verify that the redacted letter was in fact issued in connection to the Palifosfamide trials. I spoke to Dr. Chawla’s office, and a member of senior management who was there at the time of the audit and the reciept of the letter confirmed with me on two separate occasions that a) the FDA warning letter was specifically issued regarding Palifosfamide trials, including Phase II, and b) that Ziopharm had been fully informed as per FDA standard procedures on Form 483. In addition, the specific details which were not redacted, such as dates, dosages, infusion times, etc) make it instantly apparent that this letter was for Palifosfamide. So it can be said with 100% certainty that this letter is specifically for Ziopharm’s Palifosfamide trial and nothing else.

The second thing I did was to verify and re-verify that this letter had never been disclosed anywhere. Google searches make no mention of it ever and I have tried it many times. For those wishing to test this point, I suggest doing so immediately because upon publication of this article, I expect that Google searches will begin showing quite a few new results within 1 hour once these issues come to light in the press. Still in doubt, I conducted an electronic search for the term “FDA warning letter” in all of Ziopharm’s SEC filings. As shown, the only reference to FDA warning letters comes from the disclosure that Ziopharm states it had not”received” one.

The third thing I did was to speak with two senior people from the FDA, including Diane Van Leeuwen who had conducted the audit in 2009, as well as a senior departmental official in WashingtonDC. Because the letter has been redacted, they would not comment on any specifics relating to it. However both of them categorically confirmed beyond any shred of doubt that the sponsor is always notified in writing and provided with the Form 483 at the conclusion of the inspection (ie. August 2009) as well as with the final warning letter (March 2010). I asked the FDA why such important information had been redacted and their answer (verbatim) was “to protect the drug company”. Dr. Chawla’s office also confirmed that Ziopharm was fully informed at every step of the way.

Finally, I personally called CEO Jonathan Lewis on his cell phone. I explained to him that I was writing an article which would appear on and asked him:

“Dr Lewis, could you please tell me why Ziopharm never disclosed the FDA warning letter given to Dr. Chawla in 2009 / 2010”.

He declined to give me any answer and suggested that if I had any questions about Ziopharm I should contact their IR department. It was certainly notable that Dr. Lewis did not seem surprised about this question and he certainly didn’t say anything like “what letter ?”. It struck me that if a total stranger were to call me on my cell phone and make such an alarmist statement, that I would certainly be shocked, I would certainly question this statement or clarify that it wasn’t true, or give any form of meaningful response. Instead I got no surprise, no response, no questions. I would strongly encourage any interested to party to contact Dr. John Lewis of Ziopharm to ask him this question directly. But for the avoidance of doubt, Dr. Lewis did not confirm or deny any details regarding the the FDA warning letter.

Finally, this letter is clearly and undeniably material.

The details contained in the warning letter / Form 483, as well as the severity of the language used by the FDA would certainly cause any reasonable investor to view them as “material”.

In the warning letter FDA makes clear that for 7 out of 12 subjects, samples were collected at substantially incorrect times by the lead investigator in the clinical trial. In addition, during 2009 there were roughly 13,000 clinical trials ongoing but the FDA issued just 18 warning letters to clinical trial investigators, many of which were only due to administrative issues. So the extent of the errors and the rarity of this event also add to the conclusion that the warning letter should be considered “material”.

Several key quotes from this letter further demonstrate its materiality to investors, particularly in light of the fact that it was directly pertaining to the lead (co-principal) investigator of the clinical trial.I encourage readers to read each of these twice.

  • “You failed to conduct the studies or ensure they were conducted according to the investigational plans”
  • “The administration of this miscalculated dose unnecessarily exposed the subject to an overdose, with the potential for increased adverse events.”
  • “Your failure to collect PK samples as specified in the protocol significantly undermines the reliability and integrity of the data captured at your site”
  • “The inspection revealed that there were numerous adverse events recorded in progress notes of subjects’ records that had not been reported on the case report forms”
  • “lack of timely adverse event information in the electronic CRFs may have jeopardized subject safety as well as the reliability and integrity of the data”
  • “we are concerned that you did not properly understand the protocol”


The FDA audit took place from August 5th, 2009 until August 27th, 2009. Upon completion of the audit, Diane Van Leeuwen of the FDA presented and discussed the findings on Form 483 with Dr. Chawla. As standard procedure the FDA notes that it shares the Form 483 with the sponsor (ie. Ziopharm). On September 14th, 2009 Dr. Chawla provided a written response to the FDA. And then on March 17th, 2010 the FDA issued a formal warning letter.

Within 2 weeks of the completed FDA inspection and receipt of Form 483,Ziopharm completed a $5 million equity offering via Rodman & Renshaw without disclosing the FDA’s written concerns about the data. Any reasonable investor who views the FDA warning letter as “material” must clearly view this omission of disclosure as a 10b-5 violation.

The sequence of events leading up to the Rodman offering also presents clear problems.

On August 7th, 2009, Ziopharm signed an exclusive financing engagement letter with Rodman & Renshaw to raise up to $10 million. Exactly one week later (after engaging Rodman), Ziopharm issued a press release disclosing Q2 results.Despite the recent appointment of Rodman to manage the stock offering, ZIOP stated, “The Company ended the June 2009 quarter with cash of approximately $4.5 million which is expected to support operations into the second quarter of 2010.” The engagement letter (which shows the date of engagement), was not disclosed until March 2011, where it was listed as a “material contract” in the 10K for 2010 (the wrong year). One week after the press release, Ziopharm filed a registration statement covering the issuance of up to $75 million in stock. The stock offering occurred less than one month after the press release was issued. On a separate note, Ziopharm board member Tim McInerney happened to be an officer at Riverbank Securities which co-led the stock offering.Riverbank notes it may “allocate of portion” of offering compensation directly to McInerney.

Viewing this sequence of events, it seems clear that any reasonable investor would come to the conclusion that Ziopharm management signed the engagement letter with Rodman with the intention of completing a near term financing. As a result, the press release stating that its cash balance would support operations for an additional 8-10 months would be viewed as extremely misleading to investors.

The Rodman offering only ended up raising $5 million so by the end of September Ziopharm would have had no more than $6-7 million in cash. (The $4.5 million previous balance was as of June 31st, 2009) Within 1 month (October 14th),Ziopharm abruptly stopped its Phase II trials early, citing “positive” data on Palifosfamide. Again, no mention was made of the data concerns cited by the FDA. A reasonable investor would likely come to the conclusion that Ziopharm should have extended the clinical trial to further validate and expand the data whose reliability and integrity had been explicitly questioned by the FDA. A reasonable investor might also come to the conclusion that with only $6-7 million in cash remaining that extending the trial was not financially possible even if it was necessary. As a result, a reasonable investor could easily come to the conclusion that the dual roles of Jonathan Lewis in serving as both CEO and CMO presented a meaningful conflict of interest. A reasonable investor would also likely view the results of the accelerated trial with significant skepticism given that the abrupt completion of the trial coincided with Ziopharm basically running out of money.

As shown below, it can be seen that in early December, Ziopharm was down to just $3 million in cash. So in early November, cash on hand would have amounted to around $4 million. Jonathan Lewis was still enjoying a $420,000 base salary and Richard Bagley was earning a $315,000 base salary. Meanwhile, payments to board members amounted to around $200,000 per year.

On November 6th, with only $3-4 million in cash left, Ziopharm issued another press release, and this time the data from the Phase II trial was not just “positive” as it was in the previous month, but instead it was described as “compelling” and it was “sufficient to proceed to a pivotal study in support of product registration”.

On the back of these “compelling” developments, ZIOP rose to nearly $4.00, double where it was at the time of the Rodman offering. The cash strapped Ziopharm then quickly completed another stock offering at $3.10, raising $45 million in net proceeds. The company reported a year end cash balance of $48 million, so it stands to reason that Ziopharm was down to just $3 million in cash before the successful offering which raised $45 million.

Moving forward a few months, the final FDA warning letter was then issued in March 2010, citing various responses given by Dr. Chawla as not adequate. Just one month after the formal issuance of the FDA warning letter, in April 2010, Ziopharm announced that it had been selected for “Best of ASCO” based on the data from the Phase II trial. Once again, no disclosure of the FDA’s concerns had been made, so presumably that would not create difficulties with ASCO.

In addition, 4 members of Ziopharm’s Scientific / Medical Advisory Boardhappen to be past ASCO presidents. As it turns out, so is Dr. Larry Norton, a paid consultant to Ziopharm who has developed the “Norton Dosing” schedule for Palifosfamide. With 5 past presidents of ASCO on the SMA board of Ziopharm, it stands to reason that Ziopharm would have little difficulty securing this honor even though only the most preliminary and cursory Phase II data had been released at that time. Presumably none of these Ziopharm insiders was aware of the recently issued FDA warning letter, otherwise they would have certainly notified ASCO.

(Note: In my next article I will be exploring the criteria and methodology used by ASCO in selecting the “Best of ASCO” winners. One would assume that due to the prestige and importance of such an honor, that these criteria are rigorous and that the rationale for the final selections are well documented and based on compelling medical evidence. One would assume.)

On April 30th, 2010, Ziopharm’s Q12010 earnings press release draws particular attention to the prestige of the “Best of ASCO” award. On May 21, Ziopharm presented a small sample of preliminary data at ASCO, again highlighting its “Best of ASCO” designation. Meanwhile the ASCO buzz helped propel ZIOP’s stock price to nearly $6.00. And then on May 26, just 5 days after the prestigious ASCO conference, Ziopharm announced a common stock offering which raised $32.8 million.

In July 2010, Ziopharm announced that the initiation of its Phase III trials for Palifosfamide, despite the fact that none of the data from the Phase II trial had been independently reviewed, and of course the FDA warning letter still remained undisclosed.

At this time, it becomes notable that Ziopharm elected to continue using Dr. Chawla in Phase III, despite the significant “deficiencies” cited by the FDA, and their potentially significant impact on the overall Phase II clinical trial data. Since investors did not know about the FDA letter, this very curious and very important decision would not need to be explained to them. However the notion that the FDA might apply greater scrutiny and skepticism to a Chawla trial would hopefully have occurred to management.

With a now ongoing phase III trial, Ziopharm was able to attract the interest of much esteemed biotech billionaire Randal J Kirk. In January of 2011, Kirk invested $10 million dollars, purchasing 2.4 million shares at a notional price of $4.80. However Kirk was also given an additional 3.6 million shares at “no additional consideration” making his effective in price just $1.92. In addition, if any of Kirk’s DNA therapy projects with Ziopharm even get past Phase I, Kirk is entitled to receive an additional 3.6 million shares, lowering his in price to just $1.20 on 9.7 million shares, representing the lowest offering price for a Ziopharm stock issuance in several years, even though the company now had over $60 million in cash and a drug in Phase III clinical trials.

Kirk was recently described by Forbes as “the best biotech investor ever”, and the facts certainly demonstrate this to be the case. Yet in Kirk’s recent interview with Forbes, it is stated clearly that “he says he didn’t even bother to do due diligence on the sarcoma drug. His real interest is in pushing forward a new type of cancer treatment from Intrexon”. The reason he did no due diligence on Palifosfamide is that Kirk has longer term ambitions for Ziopharm and he is only focused on Intrexon. As Kirk puts it, “If Intrexon’s new DNA treatment method works, Ziopharm’s current lead sarcoma drug “will be a rounding error.

It may be the case that Intrexon has tremendous revenue potential at some uncertain date in the future, but even optimists would agree that such prospects are highly uncertain and are at least 5-10 years away. Unlike most investors, Kirk can clearly afford to wait for 5-10 years to see if Intrexon will ever generate revenues, and even if it doesn’t, the loss of $50 million invested in Ziopharm represents less than 2% of his net worth. Hence Mr. Kirk’s description of Palifosfamide as just a “rounding error”.

I continue to be a strong admirer of Mr. Kirk and the technology that Intrexon is developing. While current prospects for the technology are still uncertain, I am confidant that by 2020 it has the potential to start showing meaningful results.

However, the fact that Randal Kirk did not even bother to conduct due diligence on Palifosfamide certainly raises the concern that he may not have much of an understanding of the practical implications for the drug in a real world (non clinical trial) setting.


Ziopharm’s own internal documents demonstrate that its “stabilized” Palifosfamide appears to be so unstable that delivering it could prove difficult or impossible outside of a clinical trial setting. Ziopharm has never disclosed the stability problem nor has it described how this will impact the drug’s commercial viability. Fortunately it turns out that the Ziopharm’s Protocol Documents for Palifosfamide are occasionally able to be found online in various places. These links seem to disappear frequently, so those who are interested might want to save a copy. I have also come across a number of hospitals which post all of their FDA trials protocols on their websites, which I found quite interesting.

Ziopharm’s Phase III (“Picasso”) trial for Palifosfamide involved 162 locations, with additional locations also involved in the “Matisse” trial for Palifosfamide. Each of the investigators involved is given the trials Protocol Document, which provides in depth information about every aspect of Palifosfamide as disclosed by Ziopharm.

Between the various trial sites involved, it stands to reason that there are thousands of people not employed by Ziopharm who have seen this information including oncologists, chemo nurses, pharmacists and sometimes even patients who demand to see it. In addition, there are trial locations all across theUSandEurope.

When reading the Protocol for the “Picasso III” trial, it is immediately clear that Ziopharm’s “stabilized” form of Palifosfamide appears to actually be extremely unstable in practice. Stabilizing Palifosfamide (chemical name: “isophosphoramide mustard”) is necessary because “isophosphoramide mustard is not suitable for administration because of chemical instability“.

The “stabilized” version is what Ziopharm has worked so hard on for the past 6 years, and it is referred to as Palifosfamide-tris.

Yet as shown below, relative to virtually every comparable chemotherapy treatment, Palifosfamide-tris appears to be highly unstable to the point that even delivering the drug in a real world hospital could prove to be unfeasible.

Ziopharm’s Palifosfamide-tris Protocol Documents (Section 10.2) specifically state the following requirements when administering Palifosfamide to patients,

“Palifosfamide-tris or matching placebo will be given by IV infusion over approximately 30 minutes on Days 1-3”.

“Note: Each palifosfamide-tris/placebo administration must be completed within 1 hour of reconstitution in IV bag.”

If the 30 minute infusion must be completed within 1 hour, that only leaves 30 minutes to put the solution into the IV bag, get it to the patient, hang the bag, find a suitable vein and then begin the administration. Ziopharm’s documents spell this out quite clearly. This certainly could be achieved in a clinical trial setting with very few patients per clinic and where it is possible to get one-on-one simultaneous attention from an oncologist, a chemo pharmacist and one or more chemo nurses. But it is difficult to imagine how this could possibly be done in a real world hospital, where facilities are large, staff are stretched thin and unexpected patient wait times can often run for several hours. In addition, for a clinical trial the cost of discarding the quick-to-expire Palifosfamide is not an issue because it is provided for free by Ziopharm. But in the real world it stands to reason that a drug which costs up to $50,000 per patient and which expires in just 30 minutes would face some fairly severe hurdles in administration.

So how does Palifosfamide compare to other chemotherapy drugs ?

As shown in the Cytotoxics Handbook, comparable drugs for similar indications such as IfosfamideCyclophosphamidedoxorubicin, Carboplatin and Etoposide remain stable in 0.9% sodium for anywhere from 2-7 days at room temperature. In each of these cases, stability is measured in days not minutes.

In some cases, manufacturers have arbitrarily set a limit of 24 hours on their drugs, which has resulted in a backlash from both practitioners and academics. Further clarity on this issue can be obtained from a number of recent studies, including this one:

“Guidelines for the practical stability studies of anticancer drugs: a European consensus conference”.

As shown, the study finds that 24 hour stability times create clear logistical difficulties when serving many patients and results in significant amounts of expensive drugs being discarded upon expiration. This by no means suggests that 24 hours is undoable, but instead it means that 24 hours is enough of a problem that doctors, pharmacists and academics do find it to be sufficiently problematic that they are willing to give reports and presentations on the subject.

There are some chemotherapy drugs which have a reconstitution stability of even shorter than 24 hours. In these cases (such as with Palifosfamide), it is not arbitrary or due to bacteriological concerns, but rather is due to the fact that the drug is simply less chemically stable. As the stability time drops, the problems become more severe. For example, with a stability time of less than 12 hours, a given drug would clearly not be able to be prepared in advance for next day dosing. At 6 hours, it would require multiple batches to be prepared each day because the first batch wouldn’t even last until the end of the day. Considering the logistics and constraints of delivering chemotherapy, if a drug has a stability of only 3-4 hours, it quickly starts looking almost impossible to deliver in a real world setting.

A continuing read of the Protocol Documents reveals that Ziopharm is aware of these challenges and has made efforts to mitigate the practical effects of Palifosfamide’s instability. By using a non-standard diluent (14.6% sodium chloride) to reconstitute the drug, it is possible to leave the drug in a vial with 14.6% sodium chloride for up to 2 hours before it is introduced to the IV bag, giving a total of 2 ½ hours. (Hint: the higher salt content increases the stability). Obviously some of this time is consumed by the 15 minute shaking process and in physically delivering it to the patient, so it leaves roughly 2 hours.

Unfortunately, even a quick Google search for “14.6% sodium chloride” (with no other search terms) instantly highlights 14.6% sodium chloride as a product which has been in shortage for several years. When I called the various suppliers of the 14.6% such as Hopspira, I was told that due to the shortage, they no longer sell directly to hospitals or clinics, but instead sell to distributors who can then break up the packages into smaller packages of 5-10 vials to ensure that more end users are at least getting some small amount.

Ziopharm is clearly well aware of the possibility that in real world hospitals 14.6% sodium chloride may not be available and the Company addresses this problem accordingly. The Protocol Document (Section 10.2, page 32) makes it a point to note what to do when it is unavailable.

“In the event that 14.6% Sodium Chloride for Injection is not available at the time of vial reconstitution, you may use 5% or 0.9% Sodium Chloride for Injection, however,please note that in this case, the reconstituted vial should be introduced into the 250 mL 0.9% sodium chloride IV infusion bag within one hour.”

We now have 1 hour to get the chemo into the IV bag, and then 30 minutes in which to begin the infusion so that the infusion is completed within 1 hour. This is explicitly clear in the documents.

As many people already know, 0.9% sodium chloride is a very standard diluent in hospitals because it is matches very closely with the salt content of human blood. Medical professionals must take special care to avoid administering 14.6% in place of 0.9% because accidentally doing so can be fatal or cause brain damage, as was shown in this lawsuit against Abbott Labs.

The 14.6% sodium chloride is by no means a dangerous chemical in and of itself, but it is certainly not a standard like the 0.9% solution, particularly in the world of chemotherapy.

Looking back to the Cytotoxics Handbook, an electronic search results in precisely100 hits on for “0.9% sodium chloride” whereas a search for “14.6% sodium chloride” results in precisely zero hits.

Yes, this was a fairly long winded digression, but my only point is, while 14.6% sodium chloride will slightly improve the stability specifically for Ziopharm’s only near term drug, it is not commonly used with other chemotherapy drugs. It is a “wingnut” solution, which adds one more complication for its administration. Of course in a clinical trial setting, providing the trial sites with free 14.6% sodium chloride alleviates this short coming. But as shown in the Protocol Document, each patient will receive 18 infusions of Palifosfamide, meaning that Ziopharm will need to locate and distribute as many as 180,000 vials of this shortage product every year. If this issue has been contemplated by management, then I certainly have not seen it disclosed.

Even though real hospitals (non clinical trial setting) would likely end up using 0.9% sodium chloride and get only one hour of stability, I continue to evaluate Palifosfamide on the basis that is stable for 2 hours because it can in fact be done in the clinical trial setting.

Two hours seems challenging, but if Palifosfamide can be proven to extend the life of a terminal patient, then I am 100% confident that doctors would insist on finding a way to deliver it. Of course if the true benefits of Palifosfamide turn out to be less than absolutely compelling, then it would certainly be something the doctors might give serious second thoughts to in light of the alternatives available, the cost of wasting the $50,000 treatment as well as the impact on the patient of having to wait for a pharmacist to mix a new dose in the event the first one expires and the impact of these disruptions on the other patients who are waiting for treatment. Clearly this drug would have to significantly justify the amount of disruption it would cause in any real world chemo ward.

So the question now becomes, “is 2 hours a problem ?”

Several recent studies on improving chemotherapy wait times illustrate the challenge that a 2 hour stability time presents, and a flow chart helps to explain the complexity of what seems like a simple scheduling task.

No Time to Waste: Decreasing Patient Wait Times for Chemotherapy

Improving Wait Time for Chemotherapy in an Outpatient Clinic at a Comprehensive Cancer Center

Chemotherapy Operations Planning and Scheduling

Chemotherapy Scheduling Flow Chart

Key takeaways are as follows:

At Johns Hopkins, a 75 minute unexpected wait time is still considered “on time”, even after a massive upgrade to systems and procedures. Prior to the upgrade, the already sophisticated Johns Hopkins saw 41% of patients receiving chemotherapy more than 75 minutes after their scheduled time. Even after the upgrade, 24% of patients still received their chemotherapy more than 75 minutes after the schedule time.

At MD Anderson Cancer Center, which treats just 41 patients per day, average wait times improved from 105 minutes to 89 minutes following the upgrade. However even after the upgrade, roughly 34% of patients can expect to see a wait time that is up to 2 1/2 hours. A complicated flow chart is included to help patients understand why chemotherapy scheduling is far more complicated than just showing up for a scheduled appointment and getting immediate treatment.

“Chemotherapy Operations Planning and Scheduling” notes the use of liner programming models to help optimize the many interdependent variables involved in delivering chemotherapy in a real world setting. The report also notes describes the problem in this way: “Chemotherapy operations planning and scheduling in oncology clinics is a complex problem due to several factors such as the cyclic nature of chemotherapy treatment plans, the high variability in resource requirements (treatment time, nurse time, pharmacy time) and the multiple clinic resources involved.”

Whether or not the roughly 60-120 minute stability has any impact on the commercial viability of Palifosfamide in the real world clearly remains to be seen. The fact that Ziopharm has never addressed this issue with investors creates the possible concern that it has not been properly factored into their projections for penetrating the “$1 billion market”. I for one would be eager to hear what Ziopharm thinks the impact will be, because at present it appears that zero impact is being anticipated in connection with the combination of extremely high cost and extremely short stability.

Wall St. analysts collect 6 and 7 figure salaries based on their perceived ability to tell investors how well a drug might work, what its safety profile might look like and what its odds might be of getting FDA approval. All of their analysis is (by necessity) based upon shreds of statistical data supplied directly by the company and from educated guesses based on FDA precedents.

It is now quite apparent to me that when it comes down to the practical potential for a drug such as Palifosfamide to be used in the real world, a more useful opinion can be readily obtained from any practicing chemotherapy nurse (Average salary $58,000) who is familiar with the actual use of that drug.

As should be clear by now, I have spent an excessive number of hours spanning several months to conduct my own due diligence on Ziopharm. It is also clear that I have found a number of significant issues that I feel are cause for extreme concern. Note that I have deliberately not waded into the nonsensical debate about Palifosfamide’s completely unknown effects on patient Overall Survival or Progression Free Survival, because based on the information above, I believe that those metrics are now entirely an irrelevant and hypothetical distraction.

My final observation is that I notice that despite their bullish statements to investors, Ziopharm management continues to avoid owning shares of Ziopharm while taking home significant cash compensation every year. The total share and option holdings of ZIOP management (including CEO John Lewis) collectively amount to just 2% of the company, almost all of which has been obtained through option grants. Even though ZIOP has never generated any real net income or revenue, CEO John Lewis will be taking home nearly $800,000 in cash in 2012 and has already taken home nearly $3 million in cash over the past 5 years. Just sayin’.


The information that I present in this article will certainly be alarming to most readers and investors. I have made a monumental effort to ensure that the facts and fact patterns below are presented in a way that accurately reflects how these events and data points occurred in a completely factual way. As I have uncovered and absorbed this information over the past few months, I have come to a number of significant conclusions regarding Ziopharm. I strongly encourage readers to simply evaluate the facts and fact patterns below and then form their own conclusions.

And for the avoidance of doubt, I firmly believe and stand behind every statement and fact presented in this article and to the extent that even the smallest inaccuracy is found by anyone in any part of this article I will immediately correct it and publicly explain any discrepancy.

I am always eager to hear views of readers and investors and I am always willing to publish well informed comments and opinions from readers, even when they run contrary to my own. So I encourage any interested readers or investors to send me an email with any thoughts.

Disclosure: Based on the facts presented above, I am currently short ZIOP. In fact, I went short the day I uncovered the FDA warning letter quite some time ago.

The author can be reached at

Disclosure: I am short ZIOP. 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.


ZIOP: Who did what & when ?


Ziopharm: Who Did What And When ?


Over the past few months, I have spent hundreds of hours taking a very deep look at Ziopharm (ZIOP).

Last week, I posted my detailed thoughts online in a different venue. However,the article was quickly pulled without my knowledge or permission.  This was done despite the fact that precisely zero questions or issues were raised with regards to accuracy in the article.  As a result, I am now posting all of my comments and the previous article here.

After the article was published, I received a tremendous amount of new information from a variety of new and unexpected sources. I am already evaluating and processing a great deal of new findings, and I hope to be able to share them soon.

Following my article, ZIOP issued a press release stating that my observations were both misleading and “wrong”.

A careful read of this press release is very instructive.

First, although ZIOP says I was “wrong”, they fail to cite a single event, fact or data point which is inaccurate in any way. If ZIOP or anyone else can do so, I continue to state that I will correct any such inaccuracy and explain the discrepancy. So far neither ZIOP nor anyone else has done so.

I am not trying to simply say “I was right”, instead I am trying to point out that ZIOP’s well worded press release actually fails to address any of the many significant issues that were raised, and in fact it turns out that the specific wording used in the press release could cause a reasonable investor to draw some very inaccurate conclusions. Once again, I am coming to the conclusion that ZIOP is selectively disclosing information that will be viewed as positive, while withholding information that would certainly be viewed as negative. As I show below, just a tiny bit more information from ZIOP in that press release would have clearly raised substantially more concerns, rather than soothing investors.

As always, this article is far too long. So I put some key conclusions up front. (Note: a few of these are repeated from the previous article.)

  1. Under any and all circumstances, the Form 483 / FDA warning letter were both material to investors and should have been disclosed, even if ZIOP was of the opinion that the violations had no impact on the trial.
  2. Dr. Jonathan Lewis, ZIOP’s dual CEO/CMO in 2009, signed a financing engagement with Rodman just 2 days after learning that Dr. Chawla was facing an FDA audit. This “material contract” engagement letter was not disclosed for almost 2 years, and was in the wrong company filing. After stating that existing cash was adequate in a press release, ZIOP quickly sold stock to investors BEFORE any independent audit could have been completed on Dr. Chawla’s site.
  3. The “independent audit” of Dr. Chawla’s site provides little to no comfort about the reliability of the data in Phase 2 due because of WHO provided it and WHEN it was provided.
  4. At the time of the inspection and Form 483, ZIOP had just $1-2 million in cash to support all company operations, pay employees AND fund the substantial ongoing clinical trial expenses. Within 4 weeks, ZIOP stopped the study early, declaring it a success, despite the problems which occurred at Dr. Chawla’s site.
  5. Ziopharm has not disclosed the ultra short stability of Palifosfamide, and has not incorporated the revenue impact that the short stability will have.
  6. As expected, the FDA warning letter addresses problems with the data, not the outcome measures themselves. As shown, just because the warning letter does not specifically address the outcome measures does not mean that the data is not problematic.
  7. In evaluating the “transition” from Phase 2 to Phase 3, the FDA does minimal analysis of the data or the quality of the data. The decision to proceed to Phase 3 was Ziopharm’s decision, not the FDA’s.
  8. Ziopharm has displayed an ongoing and persistent pattern of failing to disclose material negative events and data. Based on past behavior, it is unclear what information is currently not being disclosed.
  9. Most of the patients from Phase 2 are by now deceased, such that ZIOP has known the results of Phase 2 for some time. Yet ZIOP has continued to delay releasing any detailed underlying data.

Evaluating the “audit” of the Phase 2 trial

In Ziopharm’s response, they confirm that they were aware of the FDA’s significant problems which occurred at Dr. Chawla’s clinic during the Phase 2 clinical trials for Palifosfamide. When the FDA informed ZIOP of these issues, ZIOP states that they then initiated an independent audit of the data by that site from a former FDA auditor who concluded that “the the study site’s violations had no impact on the PICASSO study or the quality of data.”

This statement seems to be categorical and conclusive and would no doubt provide significant reassurance to investors.

The conclusion one might be tempted to draw is that ZIOP found out about the violations that occurred at the lead investigator’s clinic, determined that they had no impact on the study and then chose not to disclose the FDA’s Form 483 / Warning Letter because the impact was determined to be not material.

However an astute investor will quickly realize that ZIOP did not actually make that statement.

Before getting to the real problem, let’s look at a obvious problem first.

Problem #1: Under any and all circumstances, the Form 483 was material, yet ZIOP never disclosed it.

Given the severity of the problems described by the FDA in explicit language along with the rarity of clinical sites receiving such letters, just the fact that this letter was issued is a material event which ZIOP deliberately failed to disclose. Even if ZIOP had come to the conclusion that the impact was not material, the company clearly should have disclosed the event along with the view that view that it was not expected to be material. So under any circumstances, ZIOP clearly hid a material event from investors in all subsequent financings.

By contrast, just last week, St Jude (STJ) came out and disclosed that it MIGHT get an FDA warning letter, even before the letter was issued. The fact that a company discloses just the possibility of getting such a letter illustrates just how material an FDA warning letter really is.

Yes, I know what you’re thinking. You’re thinking that this is just a technicality about disclosure ahead of a financings that happened a few times over the past 2 years. You’re thinking, it’s not a big deal because all that matters now are the current prospects for Palifosfamide.

Actually, it gets worse.

Problem #2: “Auditors” are not even responsible for evaluating the impact of data on the overall study.

First off, ZIOP states in the press release that: “all data from ZIOPHARM’s Phase 2 PICASSO study at this site were reviewed by an independent, former FDA good clinical practice (GCP) auditor, and the auditor concluded that the study site’s violations had no impact on the PICASSO study or the quality of data”.

An astute reader will quickly realize that it is not the job of an auditor in any way to determine the impact of violations on the outcome of the study. In short, an auditor is not even qualified to make such a statement.

The thing to focus on here is “input” vs. “output”.

As shown in this FDA presentation, “GCP is defined as a standard for the design, conduct, performance, monitoring, auditing, recording, analysis and reporting of clinical trials or studies.”

GCP auditors are responsible for evaluating the proper implementation of methods and procedures which will ensure that the study is conducted in a way that generates reliable data. They are responsible for evaluating the input procedures. For example, the FDA warning letter to Dr. Chawla noted violations which would jeopardize the “reliability and integrity of the data” because measurements were taken at the wrong time and side effects were not recorded. In other words, the FDA simply identified areas where violations in input procedures occurred such that data input would be subject to mistakes or omissions. In addition, as part of an audit, the auditor would be expected to perform simple tasks such as doubling checking that data in the database matched the data on various source documents. The FDA auditer did not evaluate the quality of the data itself.

While it definitely sounds good to have the opinion of an FDA auditor, the fact is is that an auditor is not in any position to say that these violations had no impact on the study or the quality of the resulting data. Auditors are not qualified or responsible for expressing an opinion on the output data itself or what it means.

But even if we temporarily forget the fact that an auditor can make such a statement as that, other problems quickly arise.

Problem #3: A substantial audit could not have been completed prior to the early stopping of the Phase 2 trial

Note: I am not suggesting that no audit ever occurred, I am suggesting that it occurred well after the fact, and after ZIOP had already stopped the trial early, claiming it was a “success”.

It is very, very important to note that in its latest reassuring press release, ZIOP cleverly refrains from stating WHEN this independent audit occurred as well as WHEN the auditor conveyed this opinion to ZIOP. The importance of this will become apparent shortly. And this is a much bigger problem.

Was the independent audit of Dr. Chawla’s site completed before the Rodman financing ? Before the Phase 2 trial was concluded early due to its stated success ?

If the audit had been conducted that quickly, ZIOP certainly would have told us so, but of course they did not.

If this audit was completed after the Rodman financing then it is clear that ZIOP would have no basis for any “not material” excuse.

More importantly, if the audit was completed before September 30th, then ZIOP could certainly never justify stopping the trial early and declaring it a “success”.

Based on the information below, I am confidant that ZIOP would not have been able to conduct a thorough audit and receive such a report during that time.

Again, a timeline is helpful.

Wed Aug 05 FDA commences inspection of Dr. Chawla.
Fri Aug 07 Ziopharm signs exclusive financing agreement with Rodman & Renshaw
(Engagement letter not disclosed until almost 2 years later, in the wrong filing)ENGAGEMENT LETTER.
Thu Aug 27 FDA concludes audit, issues form 483.AUDIT DATES.
Wed Sep 09 ZIOP prices equity deal
Mon Sep 14 Dr. Chawla responds to FDA
Tue Sep 15 Equity offering closes. ZIOP receives proceeds.
Wed Sep 30 Ziopharm has officially stopped enrollment in Phase 2 due to its “success”

The FDA audit was completed on August 27th, at which time ZIOP was down to just $1-2 million in cash.

The Rodman financing was priced just 8 business days after the FDA completed its audit. This time span included Labor Day Weekend. And presumably the marketing of the deal started a few days earlier.

The FDA audit took 3 full weeks to be completed. And in fact, the independent auditor’s job is actually much more difficult than the FDA’s job in auditing Dr. Chawla’s site. All the FDA had to do was review the practices, procedures and data and then flag any problems found. By contrast, the task of the independent auditor was to review all of the extensive data and source documentation gathered from 216 subject appointments (12 patients x 18 appointments each) and then ENSURE that they were accurate and reliable enough to make the categorical statement that the violations “had no impact on the PICASSO study or the quality of data”. The burden on the independent auditor of ensuring reliability is clearly much heavier than the burden of the FDA, which was simply identifying problems. In addition, the independent auditor would certainly have to produce a written report which would document and verify these findings. The auditor would have to be extremely confidant to make such statements in a written report regarding a Phase 2 trial.

Could ZIOP find an independent auditor, get them to the site, perform all of the work and then complete a written report in just 8 business days ? For now, I am quite confidant that the answer is no.

Looking further, we can see that Dr. Chawla issued his response to the FDA on September 14th, yet the FDA makes no note of any audit occurring when evaluating his responses. It hadn’t happened yet.

Then just 12 business days later, ZIOP stopped the trial early due to its apparent “success”. So the next question is, could the independent auditor have completed this work and then written and issued his final report in just 12 business days ? Could ZIOP then incorporate that new information to make such an important decision about stopping the trial ?

Again, I am confidant that the answer is no.

Even worse, if it turns out that ZIOP did receive a clean opinion in a written report in just 12 days, then we need to give serious consideration to how thoroughly that audit was conducted. If the FDA took 3 weeks just to spot the problems, then how could ZIOP verify that the data and the trial were “bullet proof” in just 12 business days ? So bullet proof that they could then immediately halt the trial.

As a point of reference, with 216 subject appointments, the auditor would have to be reviewing all of the underlying data regarding effectiveness and side effects from source documents and verifying it against a database. This review and analysis would need to be done for 18 appointments every day.

Looking at additional dates is also revealing.

The FDA commenced their inspection of Dr. Chawla’s site on Wed, August 5th.

Perhaps by coincidence, just two days after learning that Dr. Chawla’s site was being inspected, on August 7th, ZIOP CEO/CMO Jonathan Lewis quickly signed an exclusive financing agreement with Rodman & Renshaw to complete an equity offering. Also a coincidence, this engagement letter was not disclosed by ZIOP until almost 2 years later (March 2011) and in the wrong filing (Disclosed in 2010 10K, not in 2009 10K).

On Thursday, August 27th, the FDA completed its inspection and presented and discussed Form 483 and its findings with Dr. Chawla. ZIOP was notified. At this time, ZIOP was down to $1-2 million in cash with which to run the entire company, pay its employees and pay for the trial expenses. (And as we know, clinical trials are phenomenally expensive.)

By Monday, September 7th, ZIOP would have begun marketing the Rodman equity offering which priced on Wednesday, Sep 9th. PRICING DATE. Note, this offering was priced BEFORE Dr. Chawla had even responded to the FDA.

The stock offering was set to close on Tuesday, September 15th at which time, ZIOP would receive their money. In addition to the signing and non-disclosure of the Rodman engagement letter, this is now a 3rd coincidence that the response to the FDA came at the last minute (Monday, September 14th, just 1 day prior to ZIOP receiving their money from investors. RESPONSE DATE

However, by September 30th (at the latest), the Phase 2 trial had been stopped early due to the “positive” findings.

The conclusion to be reached here is that given what we know, it seems very apparent that there was no audit of any substance conducted prior to the early stopping of the Phase 2 trial. If any actual audit did occur within that time, then its thoroughness would be very questionable given how quickly it was completed. Investors would most likely want significantly more detail about the timing and specific tasks performed in any such audit.

Hopefully ZIOP will disclose this information as soon as possible. Until then, investors have no idea as to whether any such audit was even conducted at a relevant time. (And of course, let’s now un-forget Problem #1, the fact that auditors are not the ones to even give an opinion as to the impact of the data on the overall trial.)

IN MY OPINION, Ziopharm halted the trial early simply because they were out of money and for no other reason. IN MY OPINION, Ziopharm could not have completed any independent audit of substance prior to stopping the Phase 2 trial early.

Who “received” the Form 483 / FDA warning letter ?

Anyone who has read ZIOPs disclosure in its many equity offerings will remember that ZIOP states explicitly that is has not “received” any Form 483 or FDA warning letter. ZIOP could have helped its own case by rewording this language to say something like “The FDA has not issued any Form 483 / Warning Letter to ZIOP”.

But since they did not say that, they now have a problem because they did in fact “receive” the Form 483 and FDA warning letter that were issued in connection with the clinical trial.

In the press release, they try to make this distinction.

“The Form 483 was issued directly to the independent investigator, not to ZIOPHARM.”

I will leave it up to the lawyers to determine whether or not ZIOP can be deemed to have “received” a Form 483 / Warning Letter. If the word “received” is deemed to mean that they, well…”received” the Form 483 and Warning letter, then one would expect significant repercussions.

And please note, in my article I specifically mentioned that BECAUSE the letter was issued to Dr. Chawla and not ZIOP, that ZIOP was able to have their own name redacted on the FDA website.

Do the violations in the letter even matter ?

The ZIOP press release also notes that the warning letter and Form 483 “had nothing to do with any outcome measures of the Phase 2 PICASSO study”.

That is certainly very reassuring, however it is probably a good idea to clarify what the “outcome measures” were, just to be sure.

According to, the only outcome measure listed in Picasso 2 is this:

“The primary efficacy analysis will be conducted on the intent-to-treat (ITT) population. All attempts will be made to conduct assessment of disease status every 6 weeks until progression of disease or initiating off protocol anti cancer therapies. [ Time Frame: Every 6 weeks until progression ] [ Designated as safety issue: No ]”

Clearly this doesn’t even tell us what the outcome measures are, which is notably odd.

Since this doesn’t even tell us what the So the question is, what are the outcome measures ? Let’s assume we are interested in OS and PFS.

The FDA warning letter and Form 483 did not make any explicit statement about OS or PFS (the outcome measures), nor would we ever expect it to, because that is not what warning letters do. Warning letters are issued in response to violations by investigators in conducting clinical trials which could jeopardize data or patient safety. They do not evaluate outcome measures, so this it is not a surprise that this was not mentioned by the FDA.

In addition, we might want to assume that we are interested in “safety” as well, especially since Pali is said to have far fewer side effects. Clearly the failure to record side effects would have an impact on knowing the side effect profile for the drug. So if this happens to be one of the outcome measures, then the press release should probably be reworded. Quickly.

The fact is, that by measuring PK samples at substantially wrong times, it affects the ability of ZIOP to prove that a certain dosage is achieving certain results. When the FDA reviews this in Phase III, it could prove to be an issue because of the small size of the Phase II study and the large (7/12) number of patients who were measured at incorrect times. So now we need to ask, how confidant are we that the dosage is correct and can be statistially linked to OS and PFS ?

Was it OK to keep using Dr. Chawla ?

ZIOP states that: All regulatory matters raised in Mr. Pearson’s blog entry were resolved by the investigator in full in 2010, and had no impact on the Company’s transition from Phase 2 to Phase 3.

Um, so wait a second…so the FDA audit happened in August of 2009. Then at some time ZIOP had an independent audit done to verify the quality of data and eliminate the possibility of and problems with the trial. But the issues weren’t “resolved” until 2010 ?

The fact is, this does not mean that the data had been fixed, only that the FDA had accepted Dr. Chawla’s proposed corrective actions, such as “implementing” a new policy of “double checking” patient doses before administering chemotherapy and making it a point to understand the protocol. The FDA agreed that this was a good idea and accepted that, so the regulatory aspect of this issue was then closed, because presumably Dr. Chawla had corrected the problems going forward.

From a regulatory standpoint there is no problem going forward, but clearly the decision to continue using Dr. Chawla in Phase 3 could be of concern to investors, had they known about the letter. The concern would be that the FDA might place extra scrutiny on a trial which used an investigator who received one of just a very few warning letters. From an investors point of view, there would certainly be no advantage to including Dr. Chawla in the next trial after the warning letter. Since no investors ever saw the letter, ZIOP clearly didn’t feel that investor unease with these problems even mattered. The failure to disclose the letter to investors and the decision to use the same doctor who received a warning letter in Phase 2 should be of significant concern to investors. ZIOP had choices in these matters and the decisions they made were clearly not in the best interests of investors.

Part of the problem here is that investors would expect the Chief Medial Officer to stay on top of the situation at the clinic and with the FDA warning letter, while the CEO would be responsible for the disclosure to shareholders. Because Jonathan Lewis was filling the unusual dual role of CEO/CMO simultaneously, none of this happened.

So the answer is no. It is not OK to continue using an investigator in a subsequent trial after he received an FDA warning letter in the previous trial where he was a major enroller.

Does “passing” Phase 2 mean that there is no problem ?

The fact that regulatory matters “had no impact on the Company’s transition from Phase 2 to Phase 3” is self apparent. We all know that Palifosfamide is already in Phase 3, so pointing this out is just stating the obvious. What is not obvious to some is the fact that the FDA conducts virtually no analysis of the data when a company wants to move from phase 2 to phase 3, and it certainly does not perform detailed analysis on the quality of that data. So anyone who is thinking that the FDA came to the conclusion that this drug showed promising results and then advanced it to phase 3, is clearly mistaken. When I spoke with the FDA on this matter, they made it clear that the only reason that they would halt a clinical trial due to investigator errors was if the trial was creating a significant risk to public health. So the fact that the regulatory issues “had no impact” getting to phase 3 doesn’t really mean anything. The only real hurdle for ZIOP to take their drug from Phase 2 to phase 3 is the willingness of ZIOP to keep paying for clinical trials. Because they are willing to keep doing this, they got to phase 3. Period. For anyone who thinks that a drug “passes” phase 2, they should quickly recheck the facts. Drug companies know this, and to imply anything otherwise is certainly misleading. Implying that a drug has “passed” Phase 2 trials is quite similar to using a “Best of ASCO” designation to increase the perception that the drug is being externally validated and approved in situations which are clearly not serving that function.

Does ZIOP have “issues” with drug stability ?

Press release: “Further, the Company has no issues with drug stability.”

The fact that ZIOP has “no issues” with a drug that must be administered to a patient within 30 minutes of the time it is introduced into an IV bag is a real problem. Comparable drugs for comparable indications remain stable for DAYS after reconstitution, not minutes. As I pointed out very clearly in the article, if Palifosfamide can be proven to be extremely effective in delivering a meaningful benefit to Overall Survival or a massive benefit to PFS, then doctors would certainly find a way to make this happen in just 30 minutes. And I am still certain that they would.

However no one, including ZIOP, is even claiming or expecting benefits of that magnitude. So even if Palifosfamide were to get approved by the FDA as showing some level of effectiveness, in the real world, doctors will still consider how well this drug works vs. alternative drugs. If alternative drugs are even similar to Palifosfamide, then one could safely assume that doctors would not be spending up to $50,000 for a drug that goes bad in 30 minutes and is very difficult to administer in a chemo ward due to the scheduling problems created by a 30 minute cut off. For those who need more information, my original article has numerous links to support this.

Does this mean that Palifosfamide is “unsellable” ? Certainly not. However it is undeniable that the combination of ultra short stability, extremely high price and relatively marginal benefit of the drug will make it less attractive relative to many other chemotherapy drugs. So even if we assume that Palifosfamide gets approval after its phase 3 trials are completed, these factors will have a significant impact on any ultimate revenues from selling it. Because management never disclosed the ultra short stability or the need to use a non standard diluent to extend it stability, analysts and investors have greatly overestimated the real world revenue potential for the drug. And that of course still assumes the best case that it even gets approved.

So it is very safe to say that in the event that Palifosfamide does eventually get approved by the FDA, it will generate significantly less revenues than are currently projected due to the difficulty in administering it coupled with the high cost. If it were expensive and easy or perhaps difficult but cheap and effective, there would be less of a problem. But as of now, Palifosfaide’s specific difficulties are simply not being factored in. As with the other points, I believe I made this clear in my article as well. I leave it up to individual readers to make their own estimates about how much of the “$1 billion” market” can be conquered by a drug which clearly has these “issues”.

So even if ZIOP does not have any “issues” with Palifosfamide stability, investors who care about realizing revenues in the real world probably should.

Is there a pattern of non-disclosure here ?

There is such an extensive and persistent pattern of non-disclosure of material negative events that investors now need to wonder what ZIOP currently knows an not disclosing.

In each case, ZIOP has not disclosed meaningful negative information until much later at which time it comes out with a statement that effectively says “Something bad happened a long time ago, but don’t worry because it’s all fine now”.

As always, I have multiple very specific examples to prove this.

  1. ZIOP failed to disclose the FDA warning letter which described significant problems with the Phase 2 trials of Palifosfamide until I revealed them last week. Only at that time did they tell us not to worry because they felt that those issues had no effect on the outcome measures.
  2. ZIOP failed to disclose that it had terminated its CMO for cause until months later when it issued a press release announcing the hiring of a new CMO. Once again, something bad happened a while ago, but it’s all fine now.
  3. ZIOP failed to disclose an SEC investigation into potential violations of securities law in connection with the  trials for Palifosfamide for 4 months after it was notified by the SEC. ZIOP noted that it felt that the former CMO who had been terminated was the source of the allegations. Only in December when ZIOP noted it was filing a legal complaint did ZIOP inform investors that there had been an SEC inquiry some months before, but it was all fine because the SEC was no longer seeking information “at this time”.
  4. ZIOP failed to disclose to investors a 2009 material contract with Rodman & Renshaw which was signed just days before putting out a press release which described its existing cash balance as adequate until well into the following year. Shortly after the press release came out, ZIOP issued stock. Curiously, this contract with Rodman was eventually disclosed as a material contract, but only in the March of 2011, as part of the 2010 10K (ie. the wrong year). It makes precisely zero sense for this document to be disclosed in the 2010 10K. But it does help to conceal the fact that ZIOP was already preparing for a stock offering when it announced that it had sufficient cash to last into the following year.ZIOP’s current (2012) statement that cash is sufficient to last well into 2013 is effectively the same as the one they made right before the Rodman offering.

Aside from obvious failures to disclose any material negative information, ZIOP has not been forthcoming with the data from its Phase 2 trial. A press release in January 2012 noted that “70% of events had occurred” (ie. the subjects are now deceased) along with some very positive headline numbers. Ten months later even more of the patients are deceased, meaning that by now ZIOP certainly would be able to release reliable detailed data on Overall Survival. By now it is absolutely certain that ZIOP knows the detailed results (both PFS and OS) of the Phase 2 trial, because at least 90% of the patients are by now deceased.

The data is there, and ZIOP knows what the data says.

So although ZIOP definitely has detailed information internally, it has refrained from releasing these numbers publicly. If the numbers were great, or even just good, ZIOP would certainly have released them by now. That should not be the subject of much debate. However, given the patterns we have seen in the past, it seems quite safe to say that we should expect a press release at some unknown future date which announces some positive new development at the company, along with a mention of old Phase 2 data that no longer matters. Perhaps there will be some new breakthrough with Intrexon technology, or perhaps they will stop enrollment early in another trial and declare it to be “compelling”.

While there have been some very exciting and promotional press releases and abstracts, including “Best of ASCO”, the existing data has not been well reviewed by independent doctors and scientists. The “data” refers to the detailed data underlying the headline numbers and also includes things like the photographs of tumors so that independent judgment can be made on tumor growth. Without the underlying data being externally validated, it is very easy to draw erroneous conclusions. For example, in summarizing the data for a small set of just 62 patients in Phase 2, it is clear that just a few individual outliers could skew the results dramatically, leading to a false conclusion of effectiveness simply because of a very small number of exceptional results. For example, among the 62 subjects, if 2 Pali subjects happened to live much longer than expected, while 2 non-Pali subjects died very early, it could easily be concluded that Pali delivered a significant result. This result would seem true even if the remaining 58 subjects saw very little difference between Pali and non-Pali. This cannot be determined by reading the press releases and abstracts.

ZIOP has been very quick to make headlines with ASCO presentations and in noting the progression into Phase 3 trials. But the fact remains that none of thedetailed underlying Phase 2 data has been subject to a detailed and thorough review by independent doctors and scientists. Or if it has, then the results of that have not been disclosed.

As I pointed out in my article, ZIOPs scientific and medical board consists of 4 former ASCO presidents. ZIOP consultant Larry Norton is also a former ASCO president. The close involvement of these people would likely give ZIOP a tremendous advantage in securing a prestigious title such as “Best of ASCO – 2010”, even though there was very little data to substantiate such a designation, relative to other candidates for “Best of ASCO”.

After “winning” this honor, ZIOP continues to highlight it even in recent presentations, 2 1/2 years after the fact. So ZIOP highlights this high profile positive event from 2010, while still not releasing any new data from a now mature study in 2012.

In short, if the data were good, we would have seen it by now. But the data is in all likelihoods not good, so we probably won’t see it until something positive occurs in a different study so that the positive news can be released at the same time. Clearly that is just on OPINION, so please take it as nothing more.

What is the BIG PICTURE ?

How should investors evaluate the future prospects for ZIOP ?

Will Pali get approved ?

Can it be sold in the real world ?

What other risks are there ?

The big picture items which need to be considered at ZIOP are as follows:

  1. Based on what we have seen from the preliminary headline data that has actually been released, is it even possible to accurately handicap the odds of Palifosfamide getting through Phase 3 trials? In my opinion, the answer is “no” due to the fact that not enough data has been externally validated, so it is premature to try to handicap.
  2. If it were even possible to handicap based on currently released data, just how good are those odds ? Very good, average, below average ? Again, many people like to think they can handicap FDA approvals based on precedents and trends with other companies and drugs. In reality, the only real comparison we can make is the design of Phase 2 vs. the design of Phase 3. Phase 2 was open label so doctors knew which patients were receiving the drug, so are subject to some subconscious bias. To eliminate this known bias, Phase 3 is double blind, so doctors won’t know either. This alone could likely be expected to result in a slight deterioration of the already small PFS benefit that Pali has stated.|
  3. In the event that Palifosfamide does eventually get Phase 3 approval, what impact will the ultra short stability have on its commercial viability ? Will a drug with these characteristics really be able to conquer a “$1 billion” market ?
  4. Will ZIOP face any legal risks due the omission of disclosure of numerous material events prior to raising over $100m over the past 2-3 years in public offerings ? If so, what will the financial impact be ?

Questions for ZIOP

  1. When was the independent audit of Dr. Chawla’s site conducted, how long did it take, what procedures were performed ?
  2. Why were the material Form 483 and FDA warning letter not disclosed to investors ? Did ZIOP receive a legal opinion that this was not material ?
  3. In evaluating the commercial potential for Palifosfamide, how is the short stability being factored in to revenue projections ?
  4. What was the justification for stopping the Phase 2 trial early and what internal documentation is there to support this decision?

After thoughts

When considering these major points, it is worth noting that in response to my article, ZIOP and many others have been quick to state very simply that I was “wrong”. I repeatedly encouraged readers to point out any facts or data points that they viewed as being incorrect and that I would quickly correct any inaccuracies and public explain post any discrepancy. I also included links to all of the source data so that readers could quickly verify both content and context, along with specific dates. These links included several years worth of online documents from the SEC, the FDA and from ZIOP’s own website.

So far I have not received a single correction on any facts whatsoever from anyone, including ZIOP.

As a result, I believe that all of the facts I stated still point to the conclusion that ZIOP is not disclosing information which could help investors accurately project the commercial potential for Palifosfamide. This includes both the data we need to handicap the Phase 3 trial, as well as the practical data we need to estimate market share of this drug vs. others.

Instead, ZIOP continues to issue streams of positive press releases and attend biotech conferences to promote the story, without substantiating the reasons for the excessive optimism in any way.

Disclosure: Based on the information presented above, I am short ZIOP.

Disclosure: I am short ZIOP. 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: All of the data in this article is well substantiated by publicly available information which can be found online. If I am notified of any factual errors, I will correct them promptly and note any discrepancies.


Silvercorp Documents

This page includes a series of downloadable documents which readers may find of interest in evaluating the allegations of fraud made by against Silvercorp Metals (SVM), as well as the responses to these allegations as made by Silvercorp. The following documents have all been gathered from 3rd party sites but are believed to be reliable.  These documents are provided for convenience only and this list is not intended to serve as a complete list of all documents that might be relevant to an analysis of the ongoing controversy between Alfred Little and Silvercorp. Suggestions for additional material are welcome, and any useful new information will made available here as soon as practicable.

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