Suit against Stephens alleges 'mismanagement'.
LITTLE ROCK BUSINESSMAN JENnings Osborne was so sure that his medical testing company would continue to be successful after he sold it in 2004 that he agreed to take a deferred payment of $10 million.
Osborne was supposed to receive $9 million if Arkansas Research Medical Testing LLC of Little Rock hit certain financial goals in the three years after it was sold to a company owned by Little Rock financier Warren Stephens for $20.3 million. Osborne also was going to receive $500,000 for being a consultant to his old firm and $500,000 as part of a non-compete agreement.
But Arkansas Research didn't hit its financial goals for two of the three years. Osborne blames "gross mismanagement" for causing Arkansas Research's financial numbers to tank.
"Such mismanagement drove this profitable entity into a dying enterprise," Osborne said in a lawsuit filed against the two Stephens companies. The two Stephens companies are owned by Warren Stephens, CEO of the investment firm Stephens Inc. of Little Rock, according to Osborne's attorney, Bud Whetstone of Little Rock.
Arkansas Research still is operating, but it's for sale, Osborne said in the lawsuit filed in October in Pulaski County Circuit Court.
A spokesman for Stephens, Frank Thomas, declined to comment. And the Stephens entities haven't responded to Osborne's complaint.
Osborne's deferred compensation arrangement highlights the potential problems that can develop when selling a business, said Wayne Lee, president of National Business Brokerage Inc. of Sherwood.
Lee said he wasn't familiar with the Osborne case, but he said a seller whose compensation is tied to specific future goals should keep a hand in the company to ensure the targets are reached.
He said also there should be some penalty to the buyer if the performance goals aren't met; otherwise, the new owner would have no incentive to meet them.
"Any buyer could not meet the milestones and then not owe the money," Lee said.
On one side, Lee said, a new owner will say the company has been managed as well as possible but still didn't achieve the revenue or profit numbers the seller projected. On the other side, "You've got [the seller] saying, 'You didn't manage it as well as I would have managed it.' And then the court system has to figure out who's right and who's wrong."
And that's what's on track to happen in the dispute between Osborne and Stephens.
Sometime before June 2004, representatives from Stephens asked Osborne if Arkansas Research Medical Testing Center Inc., which Osborne founded in 1968, was for sale.
Osborne said it was.
After examining the books and interviewing clients, the Stephens representatives said they were "impressed" with the business and wanted to move forward with the sale, according to Osborne's lawsuit.
The sale contract contained an "earn out" provision, which said Osborne would receive $3 million a year if the company grossed $8.4 million a year for the three years after the sale.
"Since Jennings had been in business for 35 years and was familiar with past gross sales, he did not consider there to be any risk in his receiving the remaining $10 million," Osborne attorney Whetstone said in a letter to Warren Stephens on April 26, 2007.
On June 8, 2004, Osborne sold his business to ACHR SUB LLC, which the lawsuit described as a wholly owned subsidiary of Stephens Capital Partners LLC and Stephens Holding Co. Whetstone, however, told Arkansas Business that he wasn't sure which entity had purchased Arkansas Research Medical Testing, so both Stephens Capital Partners and Stephens Holding Co. were named in the lawsuit.
The Stephens Group Inc. also had an ownership interest in Research Solutions LLC of Little Rock, which also did medical testing, Mary Good, an early Research Solutions investor, said in an interview with the Arkansas Democrat-Gazette in July 2004.
Good, dean of the Donaghey College of Engineering & Information Technology at the University of Arkansas at Little Rock, declined to comment for this story.
Stephens Medical Research LLC of Little Rock was formed in June 2004, and it had acquired an interest in Research Solutions Holdings LLC, the parent company of Research Solutions LLC of Little Rock, Larry Parrish, Research Solution's chief financial officer, said in a U.S. Bankruptcy Court hearing for Research Solutions on June 26, 2008.
David Jones, who was the CEO of Research Solutions at the time, said in 2004 that he would be the CEO of Research Solutions and Osborne's company, which was renamed Arkansas Research Medical Testing.
"The two companies will still basically be separate companies but there will be sharing of resources, sharing of personnel and ultimately some joint marketing together," Jones told the Arkansas Democrat-Gazette in July 2004.
Jones told Arkansas Business that same month that the companies were a perfect fit. Arkansas Research Medical Testing conducted phase one clinical trials, while Research Solutions conducted trials for phases two through four.
Research Solutions had been seeing some growth since it was formed in 1999. At the end of its first year, Research Solutions had less than $100,000 in revenue. But revenue grew to $1.2 million in 2000 and $3 million in 2001. Good said in 2002 that she wasn't surprised the company was doing so well.
"We knew the industry was going to do a lot of this kind of work," she told Arkansas Business at the time. "We had a very good management team that we thought could take advantage of it."
The Management Team
Within a month of the sale, Osborne said he knew the company was going to crumble, Whetstone said.
Jones and his manager, Steve Bethel, "began radical changes," Whetstone said in his 2007 letter to Stephens.
When Osborne ran the company, clients were wined and dined so they wouldn't be tempted to leave, Whetstone said. Under the new management, however, that practice was curtailed if not eliminated, he said.
Other problems also surfaced. For one thing, Bethel "went so far as to place himself as a patient in the studies that were conducted on site," Whetstone said.
Whetstone said Bethel also brought his infant child to the site and "further compromised the integrity of this study by leaving the premises when protocol required constant on-site medical monitoring," Whetstone wrote.
Bethel didn't return a call for comment for this article.
Also, the U.S. Food & Drug Administration sent a warning letter to the firm in 2007, "which in this industry is the kiss of death as far as obtaining new pharmaceutical contracts," Whetstone said.
The letter said: "From our review of the establishment inspection report and the documents submitted with that report, we conclude that you did not adhere to the applicable statutory requirements and FDA regulations governing the conduct of clinical investigations and the protection of human subjects," the FDA letter said.
Osborne's former clients started to complain to him about the business, according to the complaint, but Osborne told them he was handcuffed.
Still, the company met its financial goals the first year, and Osborne received his $3 million. But that would be the last time he would see money from the earn-out provision, the lawsuit said.
After six months under the new management, more than 90 percent of Osborne's clients had left, the lawsuit said.
"Jennings continued to protest to the Stephens' representative, but to no avail," Whetstone wrote.
Whetstone said in the letter that Jones was fired in July 2006 for mismanagement, but that didn't turn the firm around.
Jones declined to comment.
Jones' other company, Research Solutions, also started having financial trouble.
In 2006, Research Solutions reported $6.7 million in revenue, but a year later, it fell to $3.9 million, the company's bankruptcy filing said.
Research Solutions filed for Chapter 7 bankruptcy protection on May 9. It listed $1.5 million in assets and $7.2 million in debt.
Parrish, the CFO of Research Solutions, said during a bankruptcy hearing in June that the company "got into some financial difficulty. We were getting behind."
He said the company expanded into some markets that it shouldn't have gone into, but at the time it was "a judgment call."
Private and Confidential
In early 2007, even with Jones out of the company, Osborne still was unhappy with the way Arkansas Research Medical Testing was being managed.
So he turned to Whetstone for help.
"I thought it was something that could be worked out with Stephens," Whetstone said in an interview with Arkansas Business. "I didn't think either side would relish having a slugfest over this thing."
Whetstone sent his first letter to Stephens on April 26, 2007, outlining the concerns with the company.
Whetstone said in the letter that Osborne felt the mismanagement caused the company not to meet its financial goals in 2005 and 2006, which cost Osborne $6 million.
"Jennings' preference is that this matter be resolved in a private and confidential way," Whetstone wrote.
Stephens said in his response, dated May 15, 2007, that Stephens hadn't received its return for its investment either.
"[W]hile the situation at Arkansas Research Medical Testing LLC may not have lived up to the hopes of either party, Mr. Osborne has received everything that he is entitled to receive," Stephens wrote. "I understand the disappointment that is felt when a business transaction does not produce the result that one hoped for, but I do not see any unresolved issues with respect to the terms of our agreement with Mr. Osborne."
Osborne was not satisfied with Stephens' letter and had Whetstone fire off another one.
"The points in your letter would have been well taken had this been a business venture involving a start-up company rather than the purchase of an ongoing business with a proven system in place and a successful track record," Whetstone wrote on June 11, 2007.
The letter also reiterated the claim that mismanagement caused the company not to meet its financial goals.
"Under the circumstance, Jennings [Osborne] believes he is legally, ethically, and morally entitled to be paid the remaining $6 million," Whetstone wrote.
Whetstone said that after the letter was sent he didn't hear back from Stephens.
"That's just a cavalier thing to do," Whetstone told Arkansas Business. He said ignoring the letter "practically dares you to file a lawsuit."
So he did.
Osborne is suing on several counts, including breach of contract, breach of fiduciary duty and constructive fraud. He is seeking an unspecified amount of damages.
Whetstone said one of the first things he's going to do in the case is take Stephens' deposition.
"Warren may ignore us," he said. "But I'm going to be sitting across the table from him at some point in time."
By Mark Friedman