Medical Test Firm Under Grand Jury Investigation

By LAURENCE DARMIENTO
Staff Reporter

The U.S. Attorney's Office in Los Angeles has convened a federal grand jury to investigate possible criminal wrongdoing at medical device manufacturer Diagnostic Products Corp., sources said.

While the precise focus of the grand jury probe is unclear, Los Angeles-based Diagnostic Products is already under investigation by a number of U.S. agencies on various matters.

Earlier this year, the federal Food and Drug Administration, which regulates medical device firms, banned the company from submitting applications for new products while it reviewed problems with clinical trial and data collection procedures.

At the time, the Business Journal reported that insiders at the company including director James Watson, the Nobel Prize-winning scientist sold $3.6 million worth of stock before the probe was disclosed to the public.

The stories prompted an internal investigation and a Securities and Exchange Commission investigation that is still ongoing.

Meanwhile, the company remains under investigation by the SEC and the U.S. Justice Department on another matter. Last year, it disclosed that an internal audit in 2002 uncovered illegal kickbacks made by the company's Chinese subsidiary in violation of U.S. federal law.

The company maintains that senior management did not know about these payments, but it has set aside $1.4 million to cover the costs of possible future fines and penalties.

Chief Financial Officer James Brill declined to discuss the grand jury probe or whether company documents or officials had already been subpoenaed.

"We don't comment on those sorts of things," Brill said.

The U.S. Attorney's Office also declined to comment.

While a number of Diagnostic Products' problems have already been disclosed, the existence of a grand jury indicates that authorities are at least considering the possibility of criminal wrongdoing.

"When you are talking about a criminal violation there has to be intent, a deliberate failure to follow the law," said Jay Allen, a former FDA investigator. "It is more serious."

Successive problems

Diagnostic Products, a 33-year-old firm traded on the New York Stock Exchange, is a leading manufacturer of machines that can detect minute quantities of chemicals in human tissue and fluids. Its machines are used to diagnose allergies, cancers and other diseases, as well as to regulate therapeutic drug levels, among other uses.

The company recently reported record earnings of $18.6 million for the second quarter ended June 30, on revenues of $110.5 million, also a record. However, its stock has languished since March.

As of July 28, shares were trading at $38.88, down 14.2 percent year to date. The stock hit a 52-week high of $51.68 on Feb. 11.

Diagnostic Products reported in March that the FDA invoked its "Application Integrity Policy" against Diagnostic Products, which prohibits the company from submitting new product applications while the agency conducts a thorough review of company policies and procedures.

At the time, the company maintained that the policy had been invoked because of clinical trial and data collection problems linked to a single application for a new test it wanted to market for Chagas, a parasitic infliction endemic to South America.

(New tests for the company's machines must be approved by the FDA before they can be marketed in the United States.)

As reported by the Business Journal, FDA documents painted a bleaker picture, showing that the agency had widespread concerns about the clinical trial procedure, including failure to properly report study results, misrepresenting data and failing to monitor studies.

Sharon Snider, an FDA spokeswoman, said the company remained subject to the agency's integrity policy, but otherwise declined comment last week.

Meanwhile, Diagnostic has hired an FDA-approved auditing firm to review its practices, as required under the integrity policy, Brill said. It wants to resolve its issues with the FDA by sometime next spring.

As for the insider activity, Brill said the company plans to "make a presentation" in the near future to the SEC on its conclusions.

"We have been in communication with the SEC in that regard, (but) I don't think it would be appropriate to talk about conclusions until we talk to the SEC," he said.

Michele Wein Layne, assistant regional director of the SEC's Enforcement Division in Los Angeles, declined comment, citing the commission's policy of not discussing its investigations.

According to data from Thomson Financial, the February stock sales were the largest monthly total of insider sales since July 1995.

Aside from Watson, the sellers were Maxwell Salter, a longtime outside director, Sidney Aroesty, a director and senior vice president of operations, and Robert DiTullio, vice president of regulatory affairs and quality systems.

Aroesty and DiTullio have declined comment on the sales. Watson also declined comment, while Salter did not return calls.

Another possible focus of the grand jury's probe could be the illegal kickback payments Diagnostic Products has admitted its Chinese subsidiary made in that country to gain business.

The company has maintained that only officials at the Chinese operation were aware of the payments, but the investigation by the SEC and Justice Department has dragged on for a year with no conclusion.

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