Problems at Testing firm exceed initial disclosures.

The ban that the Food and Drug Administration placed on new product submittals from Diagnostic Products Corp. last month resulted from a far broader set of problems with clinical trials than the company has disclosed to date.

After a months-long investigation, the FDA found a series of "system-wide" problems with the way Diagnostic Products runs its clinical trials. The investigation had centered on an application to market a specific test for Chagas disease, according to a Feb. 24 letter sent to the company by the FDA.

The letter also indicates company officials knew about the seriousness of the inquiry as early as Dec. 30, raising further questions about the inside knowledge officers and directors had when they sold shares of stock totaling $3.6 million in mid-February. The figure is the largest monthly insider sales since July 1995, according to data from Thomson Financial.

The letter, in which the agency invoked its "Application Integrity Policy" that halted all product reviews for what likely will be at least a year, was released at the request of the Business Journal.

The seven problems included failure to report false negative and false positive study results, failure to report adverse precision studies from four clinical sites, misrepresenting data and failing to monitor clinical studies.

The letter indicates that an FDA inspector notified the company of the gist of her findings in writing as early as Dec. 30--well before the stock sales in question. Those sales were made by two company officers and two outside directors, including Nobel Laureate James D. Watson, the co-discover of the molecular structure of DNA.

"They knew the FDA had problems with the new test," said Paul Hodgson, senior research associate with the Corporate Library, a corporate governance advisory firm. "Whether they felt this would materially affect the stock price or not is the (question)," he said.

In announcing the ban on March 3, the company had only stated that the FDA had concerns arising from the investigation of its Chagas application, though company officials later admitted in an interview they were reviewing other product applications as part of an FDA-mandated audit. However, they did not acknowledge the full scope of the FDA's concerns.

The letter, however, supports the comments of industry consultants, who said the integrity policy review ban is invoked only in cases in which the agency suspects multiple problems.

"We have been in business a long time, and we have not seen one of these letters," said Allen Schwartz, a principal in mdi Consultants Inc., an FDA consulting firm. "I would say this is significant."

Company officials have said they believe they can resolve the FDA's concerns in a year. If true, analysts said the situation should not significantly affect sales--but only if the probe does not also raise questions about the efficacy of the company's existing tests on the market.

However, invocation of the integrity policy, especially when it involves system-wide problems, can lead to product recalls, according to the FDA. Company officials maintain that its hundreds of other test kits on the market are performing well.

Diagnostic Products Chief Executive Michael Ziering, who agreed to be interviewed about the company's problem two weeks ago, declined further comment last week after being asked follow-up questions arising from the contents of the FDA's letter.

Chief Financial Officer James Brill also declined comment, saying the company had made its public disclosure regarding the probe.

'For cause' investigation

FDA investigators first visited Diagnostic Products on Nov. 10 in a "for cause" investigation during review of the company's application for the new test for Chagas, a common South American disease caused by parasites. A "for-cause" inspection, as opposed to a random audit inspection, occurs when there is reason to suspect a problem with an application.

According to the FDA letter, Inspector Trudy R. Papson issued a seven-item form FDA-483, listing "deviations found during inspection," on Dec. 30.

Ziering previously told the Business Journal that the company responded to the 483 form in the first week January, and after that was waiting for an FDA approval of the Chagas application. On Feb. 19, several days after quarterly results were reported, a brief window opened during which insiders were allowed to sell shares.

Brill told the Business Journal previously that as soon as the company received word of the ban, it immediately prohibited insider sales.

It's not known whether any of the sales broke insider trading laws, although the fact that the FDA's inspector had already found serious problems with the clinical trials might raise questions.

"You are in a gray area of law here, [but] business ethics would surely dictate there should be no insider selling with that kind of information at hand," said Hodgson, who is based in Portland, Maine.

Watson sold 25,000 shares for $1,215,771 between Feb. 19 and Feb. 25, including $522,476 worth of shares on Feb. 24 and 25.

Brill has said he issued a ban on any more insider sales after the receipt of the Feb. 24 letter and any sales that took place alter that date--which would include Watson's Feb. 25 sale and possibly his sale of the 24th--occurred because the sellers were unaware of the ban.

Watson declined a request for an interview. He was the first director of the Human Genome Project and currently serves as chancellor of Cold Spring Harbor Laboratory in New York.

All the stock sales took place after Diagnostic Products' stock reached a 52-week high of $51.28 on Feb. 18, driven by a Feb. 13 earnings release which showed record sales of $104.8 million for the quarter ended Dec. 31.

Post-ban dip

Diagnostic Products' stock traded at $48.34 at the close on March 3, the last trading day before the announcement. (The ban was announced after the market closed.) The stock dropped to $45.40 the next day and had fallen to $43.30 as of March 31.

Outside director Maxwell Salter, who sold 19,667 shares for $973,742 on Feb. 19 and 20, maintained he was unaware of the FDA's concerns and was only conducting one of his regular quarterly sales as he divests himself of company stock.

"I am 84. What I have been doing for the last couple of years every quarter when the window is open is sell 10,000 shares," he said."This is really a family business, and everybody is concerned about doing the right thing."

According to data from Thomson Financial, Salter has been selling large numbers of shares during the quarterly trading window.

Brill acknowledged that company officers Sidney Aroesty and Robert DiTullio were aware of the FDA's investigation when they were unloading their stock in mid-February.

Aroesty, a senior vice president of operations and also a director, sold 20,000 shares for $975,512 between Feb. 19 and Feb. 23, while DiTullio, vice president of regulatory affairs and quality systems, sold 8,000 shares for $400,720 on Feb. 19.

Neither Aroesty nor DiTullio has responded to interview requests made through the company.

The company declined comment about whether it had been contacted by the Securities and Exchange Commission regarding the sales. SEC officials also declined comment.

The company is required to come up with a corrective plan of action that will include barring anyone responsible for the failures from any substantive authority in matters under FDA jurisdiction, in addition, future clinical trials will have to be conducted by an outside firm specializing in them.

Diagnostic Product is a manufacturer of sophisticated immunodiagnostic machines and kits that rapidly test for hundreds of diseases and substances in both human and animal tissue. The machines, which can cost over $100,000, are found in hospitals, laboratories and other sites.