Ex-IMPATH Executives Face Criminal Charges

Federal government files various charges against six former IMPATH executives

CEO SUMMARY: With the announcement by Federal prosecutors of criminal and civil actions against a total of seven ex-IMPATH executives, IMPATH becomes the laboratory industry’s worst criminal scandal. Federal prosecutors contend these executives, during their employment at IMPATH, engineered an accounting fraud that resulted in manufacturing as much as $64 million in non-existent revenue.

SIX FORMER EXECUTIVES of IMPATH, Inc. were charged by federal prosecutors of conspiracy, securities fraud, and other criminal charges. The case was announced on Wednesday, March 30, 2005 by David N. Kelly, United States Attorney for the Southern District of New York.

Federal prosecutors say these ex- IMPATH executives manipulated the company’s finances to produce as much as $64 million in “phantom revenue.” The activity described in the indictment occurred between 1999 and 2002.

Not until July 2003 was the fraud, and its magnitude, discovered. By then, Saad and Adelson were no longer employed by IMPATH. Company officials broke the news on July 30, 2003, stating that an internal investigation was uncovering “possible accounting irregularities,” of which the most significant was a material overstatement of revenues.

This announcement triggered a drop in the company’s stock price of 88%. Losses to investors approached $260 million. NASDAQ delisted the company. On September 29, 2003, IMPATH filed a Chapter 11 bankruptcy action. (See TDR, September 29, 2003.)

Topping the list of those indicted were former Chairman and CEO Anu Saad, Ph.D. and former President and COO Richard P. Adelson. Saad is facing charges that include one count of conspiracy, one count of securities fraud, two counts of soliciting proxies with false proxy statements, and two counts of making false filings with the Securities and Exchange Commission(SEC).

Charges against Adelson are one count each of conspiracy and securities fraud and eight counts of making false filings with the SEC. Saad faces a maximum penalty of 65 years in prison and fines of $15.25 million (twice the gain or loss resulting from the crime). Adelson’s charges carry a maximum penalty of 45 years of prison time and fines of $10.25 million (also twice the gain or loss from the crime).

Already Four Guilty Pleas

Four executives charged in this case have already pled guilty. They are David J. Cammarata (former Chief Financial Officer), Peter Torres (former Vice President of Finance), Karin Gardner (former Controller), and Kenneth Jugan (former National Billing Director).

In addition to the criminal counts, the SEC filed civil charges against all six, plus one other individual. Former IMPATH Vice President Robert McKie, without admitting or denying SEC allegations, agreed to settle his case by paying a $150,000 penalty and returning about $100,000 in bonuses, with interest.

Of passing interest is the fact that the company which previously audited IMPATH’s books was not charged or fined. KPMG LLPseems to have dodged all the legal bullets in this case.

Other Legal Liability

While in bankruptcy, IMPATH was purchased by Genzyme Corporation in early 2004. Federal prosecutors have declined to comment on whether Genzyme faces any type of legal liability as a consequence of its purchase of specific parts of IMPATH’s business. (IMPATH’s Cancer Registryand Tamtron business units were sold to IMPAC Medical Systems, Inc. in December 2003.)

It must be noted that both the federal indictments and the SEC civil charges describe illegal activity that does not include violation of Medicare and Medicaid statutes. The legal actions initiated against these seven individuals describe extensive and brazen manipulation of IMPATH’s financial accounts.

Lessons In Lab Management

From this perspective, IMPATH will offer lessons in corporate governance and ethics for laboratory administrators and pathologists. But, at this point, there are no formal charges of specific violations of Medicare and Medicaid laws. Assuming that federal prosecutors take no future action in this area, there are unlikely to be any new legal precedents to affect the Medicare laboratory compliance status quo.

The heart of this crime was the manipulation of IMPATH’s financial accounts. In 1999, the company began using a software system called “Impulse.” This system tracked testing and billing activity for each specimen and would generate an invoice when testing was completed. But Impulse was not linked to IMPATH’s general ledger. The staff manually posted rev- enue and accounts receivable items to the general ledger.

Exploiting A System Flaw

The defendants exploited this flaw in the system. Beginning in 1999, “all defendants except McKie routinely inflated Physicians’ Services revenue and accounts receivable to match the projections that management handed to the board.” The six defendants “sim- ply ‘plugged’ millions of dollars of fictitious revenue and accounts receivable into the general ledger and fabricated documents to conceal the variance between the amounts in Impulse and the general ledger.”

This is the classic “Ponzi Scheme” dilemma. Once the defendants started down this path, not only was it impossible for real-world specimen and revenue growth at IMPATH to grow fast enough to cover the gap, but the need to fraudulently inflate ever-greater numbers each quarter created exponential growth in the fraudulent totals. Federal prosecutors point this out, stating that “by the fourth quarter of the fiscal year ended December 31, 2002 (“FY2002”), these specially-marked entries to the revenue accounts totaled $24.2 million and accounted for approximately 50% of the revenue recorded in that quarter.”

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The Impossible Scam

That means half of IMPATH’s recorded quarterly revenue was fraudulent by the end of 2002! That becomes an impossible scam to sustain. The defendants looked for other sources to sustain the fraud. Among other things, they routinely capitalized certain operating expenses and mis-categorized other accounting entries to help manufacture a greater amount of net earnings for the company.

As the table above illustrates, in fiscal year 2002, IMPATH’s publicly-declared income before taxes was $18.4 million. Forensic accountants later determined this number was actually a loss of $14.4 million. On adjusted net revenues of $165.3 million, the net income change discovered by forensic accountants totaled $32.8 mil- lion, or 20% of revenues.

Saad, Adelson, and Cammarata were also indicted for undisclosed self-dealing. In one instance, they “misappropriated” $851,000 in IMPATH funds to exercise stock options in the first quarter of 2001. In so doing, the defendants used IMPATH’s money to fund their stock options, essentially giving them interest- free loans from the company. These actions were neither authorized nor known to the board of directors. Nor did any public filings and proxy statements filed with the SEC disclose these facts.

As described by federal prosecutors, the defendants engaged in an audacious plan to inflate IMPATH’s revenues and net profits for their self-enrichment. It is likely that this is not the only area of ethical lapse by these individuals. For example, when IMPATH agreed to pay $9 million to settle charges of Medicare Fraud and Abuse in October 2001, THE DARK REPORT pointed out that this settlement was both unusual and unsettling.

That’s because IMPATH had billed Medicare for control tests for the period 1990 through 1998. Laboratorians understand the implications of this settlement. Among Medicare’s “Ten Commandments” for laboratory compliance, “Thou Shalt Not Bill for Controls” ranks high. The fact that IMPATH management was willing to bill Medicare for controls for nine years speaks volumes about its internal controls, compliance reviews, and a cultural ethics that either couldn’t identify and fix this non-com- pliant practice—or looked the other way until the company was caught.

Compliance Deficiencies?

Viewed in the context of the Medicare fraud and abuse settlement and the cur- rent federal charges against its ex-executives, it is not a leap of faith to believe that if more rocks were turned over, additional serious and illegal business practices (particularly in coding, billing, and collections) would likely be found to have occurred during those same years.

THE DARK REPORT believes the current federal charges against Saad, Adelson, and their fellow conspirators are unlikely to have a wide impact on individual laboratories and pathology groups across the nation. That’s because these charges relate to financial and securities fraud committed by a group of individuals willing to commit major fraud for financial gain. In so doing, they incurred great risks and are finally reaping the harvest of those illegal and unethical actions.

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Saad & Adelson’s Financial Scam Unravels When Bank Audits Collateral

BY THE END OF 2002, fraudulent manipulation of IMPATH’s financial accounting system was nearing unsustainable levels. Federal prosecutors say that, in its fourth quarter 2002 financial report, such false entries accounted for 50% of the company’s stated quarterly revenue of about $50 million.

Soon, three of the key executives of this fraud would no longer be in position to cover their tracks. IMPATH’s board ousted CEO Anu Saad in February 2003. Publicly, it stated her resignation was linked to “a lapse of corporate integrity.” It was also stated that Saad would repay $250,000 to the company, but no details as to why were provided.

Next out the door was COO Richard Adelson. IMPATH announced his resignation on May 14, 2003. He was followed two days later by CFO David Cammarata, who resigned on May 16, 2003. Even with these individuals gone, the financial accounting manipulations continued. But the clock was finally ticking on this scam.

How The Scam Unravels

The story which follows is exclusive to THE DARK REPORT. It was pieced together from a number of individuals who once worked at IMPATH. Even after the departure of Saad, Adelson, and Cammarata, other defendants in the financial and accounting department continued to sustain the scam by continuing to make fraudulent entries.

Essential to this scam was the existence of two sets of books, known only to those participating in the financial manipulation. These books showed the real numbers in the Impulse software system which tracked incoming specimens and lab tests, then generated invoices. There was another set of “false” books. These incorporated the fraudulent entries which supported the manual journal entries into IMPATH’s general ledger.

It was in late June and early July, 2003 when the scheme to defraud IMPATH and its stockholders was discovered. IMPATH held a credit facility syndicated with Fleet National Bank as the leader. This credit facility was secured by IMPATH’s accounts receivables and other assets.

According to several knowledgeable sources, in late June and early July, 2003, it was time for Fleet Bank to visit IMPATH’s offices and audit the collateral securing this credit line. What happened next is the classic undoing of so many criminal enterprises.

Unintended Consequences

As Fleet’s auditors requested the documents necessary to examine IMPATH”s accounts receivables, an employee unwittingly gave them the “wrong” set of books. Instead of handing the falsified records (which supported the corporate general ledger), the individual instead provided the accurate, real financial records produced from the Impulse system.

It didn’t take long for the auditors to see the discrepancy. IMPATH’s real accounts receivables were substantially less than believed. Finally alerted to this fraud—and its magnitude—IMPATH’s board was forced to issue the fateful press release of July 30, 2003. It stated “the Audit Committee of the Company has initiated an investigation into possible accounting irregularities involving its accounts receivable which the Company believes have been overstated. The Company noted that, given the preliminary stage of the investigation, it cannot determine the financial impact but believes that it will be material.”

IMPATH was now launched on its death spiral as an independent company. It was delisted by NASDAQ on August 22, 2003 and would be in bankruptcy court just five weeks later. Following the July 30, 2003 announcement by IMPATH, investors holding its stock lost a cumulative total of one-quarter billion dollars. The magnitude of this loss played a role in the decision by federal prosecutors to prosecute this case.

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