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Questions fly over trading in Guidant stock: SEC among regulators scrutinizing share sales

November 14, 2005

A Securities and Exchange Commission investigation and a fresh batch of lawsuits are prompting more questions about whether anyone used inside information to unload Guidant Corp. shares before the company's stock began to slide.

The Indianapolis-based medical-device maker, which is riding a wave of bad news dating to last spring, disclosed Nov. 7 that the SEC launched "a formal inquiry" into certain product disclosures and stock trading.

That means the commission has questions about insider trading, and it's armed with the power of subpoena to find answers, according to Jeffrey Bailey, a former SEC attorney and current partner at the Indianapolis firm of Bose McKinney & Evans LLP.

"The only thing you investigate when you're looking at the trading is insider trading. They're looking to see if anybody was trading on material, non-public information," Bailey said.

SEC spokesman John Heine and Guidant spokesman Steve Tragash both declined to comment.

The scrutiny follows a torrent of sales by Guidant insiders since December, when the company announced an agreement to be acquired by New Jersey-based Johnson & Johnson for $25.4 billion, or $76 a share.

Since then, Guidant insiders have sold $132 million in company shares, according to records compiled by Matthew Will, associate dean of the School of Business at the University of Indianapolis.

In contrast, company insiders went nine months before the Dec. 15 announcement of the J&J deal without a stock sale.

Bailey said the commission's investigation doesn't necessarily focus on sales by company officers or board members. It could encompass anyone who traded on information that was not publicly disclosed but would be deemed important by a "reasonably informed" investor.

"There are lots of people who, in one way or another, can get insider information," said Bailey, who does not represent Guidant.

Guidant shares last week were fetching about $56 apiece, down from nearly $75 in April. The stock slid over the summer, as the company reported a string of product defects and recalls, casting doubt on whether J&J would move ahead with the deal.

J&J did back away this month, arguing that Guidant's problems gave it the legal right to do so. Guidant disagreed, and on Nov. 7 filed a federal lawsuit in New York City in an effort to force J&J to close.

The plunging stock price has cast a spotlight on insider sales that occurred at much higher prices. For example, Guidant President and CEO Ronald Dollens sold $20 million in stock-at more than $74 a share-in April.

The company's chief medical officer, Beverly Lorell, sold $3.3 million in shares six days before Guidant warned doctors about faulty defibrillators in a May 23 letter. The sales were for around $74 a share.

Will said he found it surprising that insiders would sell stock for less than they were slated to receive when the deal closed, potentially forgoing millions of dollars in profit.

"I wonder if they knew something nobody else knew," Will said. "Maybe they had an inkling the deal was going to fall through."

A growing number of class-action lawyers are wondering that as well.

One lawsuit, filed Nov. 3 in federal court in Indianapolis, notes that Guidant investors collectively saw their shares shed $5.5 billion in value from June 17 to Nov. 3. In that span, the stock fell from $72.46 to $57.57.

That lawsuit accuses Guidant executives of allowing the company to make false statements as well as failing to disclose health problems caused by Guidant medical devices.

A similar lawsuit, filed this month in New York, accuses Guidant of hiding "significant unaddressed product defect and liability issues" from Johnson & Johnson and from investors.

The suit says Guidant knew about its defibrillator problems as early as 2002 yet concealed them to keep its revenue high and to make the company an attractive acquisition candidate.

Insiders kept problems quiet in part because of greed, according to the suit, which highlights $65 million in insider sales.

However, Bailey, the former SEC lawyer, cautions there may be entirely legitimate explanations for trades that in hindsight look curious.

Some executives, for instance, file plans to sell a set number of shares within a time frame but relinquish authority on when to pull the trigger. They also can arrange in advance to sell stock if it reaches a certain price, with the transaction occurring automatically.

Executives also might sell shares after exercising options that are due to expire. Some of the proceeds from such sales typically are used to pay taxes. Another possibility: The executive needs cash to pay a big bill like a child's college tuition.

"In order to know why they did it, you really have to know what their personal situation is," he said. "To know why those guys sold, you'd have to put them under oath and ask them to explain it."
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