JOHN BABISH'S DEFENSE: PART I
I have a long document that I scanned in. I will post it in several posts, and some of it will have to go up tonight or tomorrow. I lose all formatting when I post it, and trying to get the formatting back takes a lot of time. This is in John Babish's defense in PRLN's lawsuit against him. One can infer from the defense what the charges are. This is material that is in the public domain. The only tampering I've done with it is in the formatting.
Robin
UNITED STATES DISTRICT COURT
NORTHERN DISTRICT OF NEW YORK
PARACELSIAN, INC., a Delaware
Corporation
Plaintiff,
97-CV-604 (RSP) (GJD)
v.
JOHN G. BABISH,
Defendant.
DEFENDANT'S AFFIDAVITS IN SUPPORT OF ITS
CROSS MOTION TO DISMISS AND IN OPPOSITION TO
MOTION FOR A PRELIMINARY INJUNCTION
Affidavit of John G. Babish
Affidavit of John Moss Hinchcliff
Affidavit of Arthur A. Koch, Jr.
Affidavit of Ronald J. Folk
UNITED STATES DISTRICT COURT
NORTHERN DISTRICT OF NEW YORK
PARACELSIAN, INC., a Delaware AFFIDAVIT OF
Corporation, JOHN G.BABISH
Plaintiff,
97-CV-604 (RSP)(GJD)
v.
JOHN G. BABISH,
Defendant.
STATE OF NEW YORK )
COUNTY OF TOMPKINS) ss.:
JOHN G. BABISH, being duly sworn, says:
1. I am the defendant in this action, and I submit this
affidavit in opposition to plaintiff's motion for a preliminary
injunction. Plaintiff's motion makes several distinct allegations, and I respond to them in separate sections of this affidavit. This affidavit addresses: (1) Paracelsian's history and relevant background facts that set the stage for this lawsuit; (2) the circumstances surrounding the negotiation of a renewed employment agreement and my sales of stock; (3) my resignation and conversations with Lee Henderson; (4) my removal of documents from my office at Paracelsian; (5) my business activities since my resignation, including my unsuccessftil attempt to set up a company that would have been called
"ParaDocs"; and (6) the impact that imposition of an injunction
would have on me.
1. Paracelsian 's History and Relevant Background
A. Formation of the Company
2. In 1991, I arranged the incorporation of Parcelsian, Inc. as
part of what I hoped would be a successful transfer of academic
technology into the commercial world. As an Associate Professor
of Pharmacology and Toxicology at the New York State College of
Veterinary Medicine of Cornell University, I had identified a novel
cellular pathway that could be used to identifiy chemicals that have
positive or negative effects on both normal and cancerous cells. In
essence, my screening techhnology enables a researcher to assess
whether the substance causes or "cures" cancer.
3. Cornell University has many scientists whose discoveries
may have commercial potential, and Cornell has established a
subsidiary to assist its scientists in transferring new technology to
commercial enterprises. Cornell Research Foundation, Inc. is the
entity through which Cornell allows its scientists to license from
Cornell the patents and other intellectual property developed by
Cornell employees such as me.
4.In conjunction with the creation of Paracelsian, I arranged
for the new company to enter into an exclusive license agreement
with Cornell Research Foundation, Inc. so that the company would
be able to exploit my screening technology commercially.
B.Paracelsian's Technology and Scientific Strategy
5.The company has always focussed its efforts on herbs used
in traditional Chinese medicines ("TCM"). Many of these herbs
have been used medicinally for thousands of years, and Chinese
physicians who continue to prescribe them have considerably more
training than shamans or other indigenous people who use plants
medicinally. I therefore believed (and continue to believe) that
TCM's have a greater potential to contain therapeutic and non-toxic
compounds than randomly selected herbs and plants. In short, by
starting with TCM's, I believed the company would be able to
identifiy, obtain, and market useful compounds much more quickly
and efficiently than if the company started with plants that did not
have known medicinal properties. The Company's 1995 Annual
Report (submitted as Defendant's Exhibit A), at page 7, puts the
strategy thus: "By using the information available to the Company
from traditional use in China, it is possible to eliminate further
development of compounds that would be excessively toxic to
humans or have poor bioavailability."
6. In 1994, Paracelsian acquired a library of TCM's by
acquiring Pacific Liaisons, Inc. This library of approximately 3,000
herb extracts has been the sole focus of Paracelsian's screening
since 1994. As of March 1997, when I resigned, the company's
scientists had screened approximately 1,000 of these extracts (the
1995 Annual Report states on page 2 that the library includes over
2,800 extracts of which the company had screened approximately
700). We of course started with what we believed to be the extracts
with the highest potential for therapeutic value and the lowest
potential for toxicity. From the initial screens, the company
continued the screening process in an effort to isolate the specific
compound(s) that provided the therapeutic effect.
7. The Company's screening process is proprietary in two
ways. First, the company has a cell line that it uses for its screens.
That cell line has reproductive and other qualities that enable the
company to efficiently conduct its assays (tests). The "parent" cells,
from which the company can grow additional cells for its tests, are
kept in liquid nitrogen at the company's premises. The actual tests
that the company performs on these cells are not proprietary;
indeed, these testing processes are widely known in the field and
have been used for years. The second proprietary aspect of the
Company's work is the library of TCM extracts. Although TCM's
are readily available from dealers in China and from brokers in the
United States, having a library of extracts provides the Company
with an efficient starting point for its research. Stated most simply,
it is the "ingredients" of the testing process (the cells and the
library), but not the testing process itself, that is proprietary.
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C. Parcelsian's Impetus for This Lawsuit
8. I believe that Paracelsian has started this lawsuit against
me in a preemptive effort to stop or impede an investigation into
illegal activities by Keith Rhodes and the remaining members of the
Board of Directors. The Court should understand the events that
preceded Paracelsian's filing of this suit.
9.Since November 1996, the Company has averaged a loss
of about one senior executive or board member per month, with no
replacements. All of the Board members with scientific training and
marketing experience have resigned, as have all three of its
remaining vice presidents. Specifically, Dr. Michael A. Gallo
(director), Dr. T. Colin Campbell (director), Mr. William J.
Warwick (director), Dr. Stephen Ip (vice president), Arthur Koch,
Jr. (vice president/CFO), and I have all resigned. I believe that the
Board currently consists of Keith A. Rhodes (who is, I believe, also
the company's President, Chief Executive Officer, and Chairman of
the Board), James Nichols, Theodore P. Nikolis, and Jack O'Reilly.
None of these people has any scientific background or credentials in
science, marketing or consumer products.
10.On April 15, 1997, attorney Charles J. Hecht wrote a
letter to the remaining Board members on behalf of myself, T. Colin
Campbell and other shareholders, a true copy of which is submitted
as Defendant's Exhibit B. The letter identifies five specific unlawful
or ultra vires acts of Mr. Rhodes, which I briefly summarize below:
a. Mr. Rhodes issued 200,000 shares of stock, worth
$375,000, to a Pakistani national, who in turn sold that stock to a
U.S. stock promoter in violation of SEC rules. The 1995 Annual
Report (Exhibit A at 25) states that the stock was issued to pay
consultants in connection with research into Indian sourced herbs.
Mr. Hecht's letter states, and I now believe, that there was no such
study conducted. The issuance
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of that stock was therefore ultra vires, the company having received
no consideration for it. Mr. Rhodes' action in issuing the stock was
unauthorized by the Board, and indeed neither I nor Mr. Campbell
nor at least several other Board members had any knowledge about
it until we saw the 1995 Annual Report. The Company's attorney,
Michael D. Pinnisi, has in a May 5, 1997 letter to Mr. Hecht
(submitted as Defendant's Exhibit C) admitted that "Our review of
the Board minutes to date shows no record of Board authorization
Certainly in the weeks since Mr. Hecht sent his letter of April 15th,
the company has not produced any evidence of either the Board's
authorization nor of any "consultant's" report on any Indian herbs.
It would be curious indeed for the Company, which was formed
specifically to conduct screening tests, to hire a consultant to do
such tests for the Company. These issues are outlined on pages 2-5
of Mr. Hecht's letter (Exhibit B).
b. Mr. Rhodes and Jack O'Reilly engaged in improper self-dealing.
The company hired a "headhunter," Catalyx Group, Inc., to find a
new member for the Board of Directors and paid that company $
15,000. The new member found by the headhunter -- Jack O'Reilly
-- turns out to have been Catalyx's president and controlling
shareholder. That obvious conflict of interest was not disclosed to
the Board. Thereafter, again without disclosure of the conflict,
Paracelsian hired Catalyx to conduct a "validation review" of the
Company's research and development activities; although the
company paid Catalyx the full $20,000 for this review in December
1996, it had not received a final report or presentation to
management before I left the company in March 1997 Additionally,
the company paid another $8,000 in satisfaction of Catalyx invoices
which contain no description of services. These issues are
addressed on pages 4-5 of Mr. Hecht's letter (Ex. B)
c. During fiscal 1995, Paracelsian issued securities in a private
placement which resulted in expenses and closing costs that
consumed over 23% of the proceeds, an amount far above normal.
See Hecht letter (Ex. B) at 7-8.
d. Mr. Rhodes sold convertible preferred stock lacking a
redemption floor or a fixed conversion price, which effectively
allowed purchasers of the preferred stock to convert to an unlimited
amount of common stock. As a result, when all of the preferred
stock had been converted, the company suffered a two-fold dilution
of its stock. Mr. Rhodes had sold 50% of the company for only
$5.7 million. Not surprisingly, issuance of the convertible preferred
stock had a negative impact on the stock price and resulted in
additional dilution for the preexisting common stock shareholders.
Apparently in an effort to shore up the stock price, Mr. Rhodes
initiated a stock buy-back program. At least 96,450 shares were
purchased by the company without Board authorization, resulting in
the expenditure of over $1.3 million. These issues are addressed on
page 8 of Mr. Hecht's letter. The company's counsel admits that
"Our review of the Board minutes to date shows no authorization .
. ."(Ex. C at 2)
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e. Finally, the Company has failed to call an annual
meeting, in violation of the corporation's by-laws and Delaware
law. (See Ex. B at 8-9)
Mr. Hecht's letter demanded that an independent cominittee of the
Board conduct an investigation into these very serious allegations
of mismanagement and illegality. Mr. Hecht's letter concludes with
the statement that if no meaningful response is received within 10
days, his clients (of which I was one) "will take all necessary and
appropriate steps to protect Paracelsian's interests." As reflected in
Mr. Pinnisi's May 5th letter (Ex. C at 1-2), the Company has
apparently read Mr. Hecht's letter as a threat to commence a
shareholder's derivative action. I understand that the Company is
also afraid that Mr. Hecht will commence a proxy contest for the
election of new directors.
11. I believe that Paracelsian's suit against me is an effort
by the company to prevent me from working with Mr. Hecht to
address the issues outlined above. I was an officer and director of
the Company at the time these actions were taken, and although I
had no knowledge of any of these improprieties at the time they
occurred, I may very well end up as a defendant in a shareholder's
derivative action. The TRO and proposed preliminary injunction
have prevented me and would continue to prevent me from taking
what I believe are appropriate steps to rectifiy the wrongdoing
outlined above, including working with Mr. Hecht.
2. My Emyloyment Contract Negotiations and My Sales of
Paracelsian Stock
12. My employment contract with Paracelsian expired on
September 30, 1994. I thereafter sought to negotiate a renewed
contract, but from 1994 through approximately the summer of
1996, I was unable to get Mr. Rhodes to focus any serious attention
on this issue (despite the statement in the 1995 Annual Report (Ex.
A at 41-42) that "The Company is negotiating the terms of a five-
year employment agreement with Dr. Babish"). At around that
time, in my frustration with trying to get
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a contract proposal from Mr. Rhodes, I insisted that the
negotiations be conducted by a committee of the Board, and I told
Mr. Rhodes that I would hire an attorney to help me with the
negotiations.
13. On November 18, 1994, the company issued to me 375,300
warrants which entitled me to acquire that number of shares of
common stock at $3.25 per share. The warrant certificate expressly
states that the company covenanted to register the warrants with
the SEC and would use its best efforts to have the SEC accept the
registration statement. The company did not file a registration
statement, and the warrants are still unregistered and therefore
untradable.
14. On or about November 20, 1996, George Lander, an
attorney at Morse, Zelnick, Rose & Lander, counsel for
Paracelsian, sent a proposed employment contract to the attorney I
had retained to help me with the negotiations, Gordon Forth, of
Woods, Oviatt, Gilman, Sturman & Clarke. Although I was not a
participant in the direct discussions between the attorneys that
followed the preparation of the draft, I know that the discussions
were not productive. In December 1996, in response to the
unexplained mismanagement of Keith Rhodes as CEO, the Board
created the Office of the Chief Executive. See Board of Directors
minutes from December 10, 1996, submitted as Defendant's Exhibit
D. Starting in December 1996, as part of the Office of the Chief
Executive, I met with some frequency with Mr. Rhodes and with
Arthur A. Koch, Jr., the other member of the Office. On several
occasions, the dates of which I do not recall, I told both Mr.
Rhodes and Mr. Koch that I was very unhappy about the progress
of the employment contract negotiations and that if the company
didn't make a realistic proposal I would have no choice but to leave.
Thus, I specifically dispute and deny the allegations in the complaint
(see, e.g., Complaint 35 (a copy of the complaint was submitted as
Exhibit A to plaintiff's motion papers) that I concealed an intention
to sell stock and resign. My intent to sell stock was disclosed to the
world in my SEC filings, as was
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the actual fact of my sales and the amounts of sales and prices
obtained. I did not have any intent to resign in January and
February 1997, but I had specifically told Mr. Rhodes and Mr.
Koch that if I did not get an acceptable new employment contract, I
would resign. At the time, I thought the company would in fact
make a realistic proposal.
15. By mid-January 1997, contract discussions were still stalled. I was increasingly frustrated and angry. I also had some substantial bills to pay, including an overdue tuition bill for my son's college, bills for attorneys fees and other personal expenses. I concluded that I should sell some of my Paracelsian stock to raise cash to pay these bills, but also to send a message to the Board that the company needed to deal seriously with the employment contract
issue. I had previously registered with the SEC to perrnit me to sell
some of my shares, and as of January 1997, I still was authorized
under those prior registrations to sell up to 69,000 shares. On
January 21, 1997, I instructed my broker to begin liquidating up to
69,000 shares. In early February, I filed a form 144 with the SEC to
register an additional 246,675 shares, so that I would be legally able
to sell up to that number of shares if I so chose.
16.On February 10, 1997, my attorney Gordon Forth faxed to
Paracelsian's attorney a written response to the company's
November 20, 1996 draft. A copy of my attorney's fax is submitted
as Defendant's Exhibit E. Throughout my unproductive discussions
with Mr. Rhodes over the prior two years since my old contract had
expired, I had insisted that a renewed contract have an effective
date of October 1, 1994-- the date following expiration of the old
contract. As Mr. Forth's fax makes clear in paragraph 1, the
Company had agreed to that demand and by February 1997 I was
expecting that the renewed contract would provide for the payment
of approximately $156,000 as a retroactive raise.
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17. As reflected in the SEC form 4's (Exhibit D to the Pinnisi
Affidavit), I started selling stock on January 21, 1997. The form 4
reporting my January sales was filed on February 10, 1997. I
believe that the SEC puts the filing of both form 144 and form 4 on
its EDGAR electronic reporting system, from which that
information is readily available to investors. Certainly the fact of my stock sales was not a secret.
18.Throughout February and into early March I continued to
have meetings with Mr. Rhodes and Mr. Koch at which I expressed
my frustration and indicated that if we couldn't negotiate the terms
of a new contract I would have no choice but to leave. I still
expected that the company would present a reasonable offer, and I
most assuredly did not have any plan to resign at any particular
point in time.
19. On or about February 26, 1997, T. Colin Campbell (who
was then a Board member but who has since resigned) spoke with
me and asked me to stop selling shares. I expressed to him my
frustration over the contract discussions, and he said he would see
if he could push the discussions forward. I respected Mr.
Campbell's request, and I did not sell any more shares until after my
resignation was made public. I also told Mr. Koch that I had
stopped selling shares.
20. On or about March 10, 1997, Paracelsian's attorney sent my
attorney a draft of a new employment agreement. As reflected in
the transmittal letter (submitted as Defendant's Exhibit F) the
proposal included an effective date of March 1, 1997, despite what
I had believed was the company's prior agreement to make the
effective date run from the end of my last contract in 1994.
21. The company proposed to cancel my unregistered warrants
in exchange for certain payments and stock options that were worth
considerably less than what the warrants would have been worth
had they been registered as the company had promised.
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22. The March 10 proposal also provided that the renewed
contract would last only until September 30, 1998--just over a year,
despite my understanding that we were negotiating a contract that
would resolve the issue for at least 3 years.
23. In short, I viewed the March 10 proposal from the
Company to be a significant step backwards from where I thought
we were in the negotiations, and it was at this point that I first
started thinking that I would in fact quit in the immediate future
24 I tendered my resignation on March 19, 1997 (a copy of my
resignation letter was submitted as Exhibit E to Mr. Pinnisi's
affidavit).
25. I understand that certain members of the Board, including
T. Colin Campbell, thereafter tried to persuade the Board not to
accept my resignation and to find some mutually agreeable basis for
a new employment contract. Other members apparently remained
"steadfast" in their views that "whatever happens to Paracelsian in
the future the company would not succeed with Babish in his
current role." See Board of Directors minutes dated March 25,
1997 (submitted as Defendant's Exhibit G), particularly the last
page.
26. At all times in January and February 1997, when I was
selling shares, I believed that the company would make a reasonable
proposal for an employment agreement and that I would not need
to resign. I also believed that the Company was actively searching
for a new CEO to replace Mr Rhodes, and I firmly believed (and
still believe) that the company would be much better off once
Rhodes leaves. It was not until the events in March that I realized
there was no hope for a renewed employment contract.
27. The complaint alleges that I intended to buy back
Paracelsian stock after my resignation so that I could acquire
control of the company, using the proceeds from the sales I had
made prior
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to my resignation. That allegation makes no factual or financial
sense.
28. By January 1997, my holdings in Paracelsian stock had been
diluted to the point that my ownership interest was down to less
than 4% of the common stock (as of January 1, 1997, there were
over 11 million shares outstanding, and I owned 348,100 shares of
common stock (the warrants, as noted above, were unregistered
and therefore unable to be traded)). Even if I had sold every one of
my shares prior to my resignation for the approximately $2.00
average price at which the stock was trading in January and
February, I would have netted under $700,000. Furthermore, if my
resignation had resulted in a drop in the price to $0.50 per share
(which I certainly would not have anticipated, since the previous
low, set back in mid-1996, was about $0.88), that $700,000 would
have purchased only 1.4 million shares. I would then have owned
less than 13%-- and of course if I had tried to acquire 1.4 million
shares, the price of the stock would most certainly have gone up
well beyond $0.50 per share. Put simply, the scheme that plaintiffs
accuse me of would have been sophomoric and could not possibly
have worked.
29. After the company issued a press release announcing my
resignation, I sold 25,000 shares on March 24, 1997 at $1.275 per
share. I sold an additional 2,500 shares on March 25, 1997 at
$1.125 per share. I sold 33,000 shares on April 18, 1997 at
$0.51890 per share, and 10,000 shares on April 22, 1997 at $0.53
125 per share. Copies of the trade confirmation notices for all of my
1997 Paracelsian trades are submitted as Defendant's Exhibit H. In
preparing this affidavit, my counsel discovered that two trades from
January 1997 apparently were not reflected in the Form 4 filed with
the SEC on February 10, 1997. Advest (my stockbroker) sent
copies of the January trade confirmations and monthly statements
to Paracelsian's attorney, George Landers, who prepared the Form
4 for the January sales. Despite my calls to Mr. Landers on
February 10th (the day the Form
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4 was due), he did not fax me the completed forms for my signature until very late in the afternoon. In the rush to get the forms into the Federal Express system by the deadline, I did not have the opportunity to compare my trade confirmations with the information
prepared by Mr. Landers. In any event, I had no reason to doubt that Paracelsian's attorney had completed the Form 4 accurately. I do not know how or why the two trades were apparently omitted, but I certainly was unaware of the omission when I signed the
Form 4. |
