Boston Scientific and the Road to Ruin

By Catherine Elton | Boston Magazine |

THIS SPRING, BOSTON SCIENTIFIC cofounder Pete Nicholas took to the stage at the end of a shareholders meeting to deliver “a few words.” Nicholas began his remarks by reminiscing about 2004, the 25th anniversary of the Natick-based medical device powerhouse. Back then, he said, Boston Scientific was the “unambiguous leader” in its industry, universally acclaimed for its phenomenal success and place “among the top 100 most valuable companies on the New York Stock Exchange.”

[sidebar]The 50 or so suits scattered in the largely empty downtown Boston auditorium remembered the time well: The company’s stock that year hit an all-time high of $45 a share.  

But then Nicholas recalled the years that followed: the company getting sanctioned by the FDA; seeing the market for its devices stall; and making what has since been dubbed the second-worst acquisition in the history of corporate America. Along the way, Boston Scientific’s stock price slid into single digits.
 
Nicholas’s comments were direct and honest, but it would have been difficult for any executive to put into words just how severe the turn in the company’s fortunes had been. Boston Scientific prided itself on being an innovative force that pushed the possibilities of medical technology. But that ambition also fostered a culture that on too many occasions had pushed beyond legal, ethical, and financial boundaries. Fed by hubris, testosterone, ego, and greed, the company slogged through a now-legendary string of operational and strategic blunders, quality-control problems, and allegations of outright corruption. “What’s next?” a Wall Street analyst had asked in the middle of it all. “Locusts?”

Actually, with respect to Nicholas’s attempts to revitalize the company’s battered image, a plague might have been preferable to what he was about to announce. Standing behind Nicholas, listening to a speech that had quickly turned gloomy, was Boston Scientific’s president and CEO, Ray Elliott. Renowned as a turnaround artist who could resuscitate struggling organizations, Elliott had, to much fanfare, agreed in 2009 to come out of retirement and staunch the bleeding at Boston Scientific.

But now even he was bailing. “I heard from Ray about a week ago that he would like to now step down,” Nicholas said. “We reluctantly accepted his wishes.”

Despite the significance of the development, the auditorium remained eerily quiet. On Wall Street, though, analysts were gasping. “Very surprised,” “Shocked,” and “Gobstopped” typified the reactions. Shares of the company’s already beleaguered stock plummeted another 10 percent, to less than $7 by the close of the market.

Boston Scientific remains a giant. The company employs 25,000 people worldwide and has revenues of $8 billion. But Elliott’s departure came as the nadir in a long run of bad news. It reinforced the company’s image as the premier problem child in an industry with no shortage of problem children, and as the shareholders meeting came to an end, it left hanging in the air a couple of critical questions: How the hell could things at a company this great have gotten so bad? And could Boston Scientific possibly recover?

THE STORY OF BOSTON SCIENTIFIC began with a chance encounter in 1979 on the sidelines of a soccer match in Concord. John Abele, an unassuming technological visionary, and Pete Nicholas, an aggressive businessman, were watching their kids play and ended up talking. Nicholas was looking to build a new company. After that day the two kept talking, eventually raising the funds to create a holding company that purchased the firm where Abele worked, the catheter technology concern Medi-Tech. They settled on the name Boston Scientific.

Over the next decade, the yin-yang pair pursued the common goal of pioneering less-invasive medical technology. In 1990 they introduced a new device, a balloon to widen clogged aortic valves, that was a big enough success to lead the company to an initial public offering in 1992. In time, Boston Scientific would develop catheters and stents, which help restore the flow of blood through weakened or blocked arteries.

In the mid-1990s, Abele retreated from day-to-day operations and took a seat on the board of directors. Nicholas then brought on the brash dealmaker Larry Best to serve as chief financial officer (or, as one analyst later put it, to play Rasputin to Nicholas’s empress).

Starting in 1994, Boston Scientific acquired nine companies in 16 months and saw its market capitalization go from $1.5 billion to $8.5 billion in one year. In 1995, Nicholas bought the Minnesota-based coronary catheter maker Scimed, and overnight his company doubled in size. But Nicholas had even grander plans: He wanted Boston Scientific to become the biggest medical device firm in the world.

Pictured above, Jim Tobin and Pete Nicholas, photograph by Jonathan Wiggs/The Boston Globe via Getty Images.

The company came to dominate the so-called interventional cardiology device market, a multibillion-dollar sector comprising various types of stents and catheters. Boston Scientific advanced medicine and, arguably, humanity by bringing lifesaving medical devices to market. It also became an investment portfolio darling, and made its founders billionaires. In 1997, an article in Medical Economics summed it up this way: “What could go wrong with such a success story?”

Plenty, as it would turn out. The company’s phenomenal growth led to some spectacular problems — arrogance, avarice, and treachery among executives and the rank and file alike — which became so embedded in the culture of Boston Scientific that even now, nearly two decades later, the company is still unspooling its infected threads. (Despite repeated requests, Boston Scientific officials declined to comment for this story. Ray Elliott would answer only limited questions.)

THERE ARE TWO CASES that best illustrate all that has gone wrong with Boston Scientific.

The first began in 1995, and involved an Israeli war hero and his wife. Kobi and Judith Richter owned a company called Medinol, which held a patent for a stent — a small metal-mesh tube that, after being threaded to the heart, expands to prop open clogged arteries.

At the time, Johnson & Johnson had just released the first coronary stent on the U.S. market — and Boston Scientific and Johnson & Johnson were far from friendly. The two behemoths had a tendency, as one former Boston Scientific executive put it, “of buying companies out from each other’s noses.” Their competition became ferocious, which may have had something to do with the fact that J&J had at one point tried to acquire Boston Scientific — which did not go over well in Natick. In working with Medinol, then, Boston Scientific may have seen not just a good business deal, but also a chance to stick it to J&J by getting in on its stent action.

Medinol and Boston Scientific drew up a contract under which the Richters’ company would make its metal-mesh stents, called Nir stents, and Boston would market them. But the arrangement proved troublesome. The Richters were difficult to deal with — they missed deadlines and kept asking for more money, according to a suit filed by Boston Scientific. (The Richters denied these claims.) So Boston Scientific looked for a way around Medinol. Pete Nicholas and his CFO, Larry Best, ordered the construction of a top-secret manufacturing facility in Ireland called Project Independence. They also created a shell company, which carried the pseudonym BBD (as in Bringing a Better Deal). According to allegations in a lawsuit filed years later by the Richters, the purpose of the secret facility and shell company was to steal Medinol’s stent design so that Boston Scientific could manufacture them on its own and either cut Medinol out of the deal entirely or depress the company’s value to the point where Boston Scientific could acquire it at a fire-sale price.

By the time of the Richters’ lawsuit, Pete Nicholas had himself taken a seat on the board and named Jim Tobin as Boston Scientific’s new CEO. The Richters claimed in court documents that Tobin had told them that his colleagues were “crooks” and that he was “ashamed to be working for such a dishonest company.”

In court proceedings Tobin denied that he had ever made those comments. Boston Scientific countersued the couple, and insisted that the secret facility was developed as a backup plan because, the company said, the Richters had fallen behind in production. In a summary judgment weighing both suits, a judge determined that Boston Scientific had acted in bad faith. The company settled and paid Medinol $750 million in 2005.

But the tale of the Nir stent involves allegations far worse than double dealing. According to the U.S. Attorney’s office, an investigation revealed that within weeks of launching Nir on the U.S. market in August 1998, Boston Scientific received reports of life-threatening problems with the stent’s delivery system. Some of the balloons used to expand the stent to its full size leaked or burst. According to a resulting lawsuit, Nicholas admitted in a conference call that he knew the Nir stent was faulty and that the company couldn’t continue to sell it. But it did anyway. Boston Scientific kept the faulty product on the market — making $1.5 million in sales each day. The company did send out a letter to physicians that mentioned the flaws, but tried to downplay them.

The FDA found out about the stents and ultimately met with Boston Scientific to discuss them. By that point, one person had died and 26 had been injured due to the flawed stent, according to the FDA. On October 5, 1998, Boston Scientific issued a recall. In 2004, the company paid the government $74 million to settle the case. It admitted no wrongdoing.

ANOTHER CASE EMBLEMATIC of the problems at Boston Scientific was the purchase of the Indiana company Guidant. By 2005, with revenue in the billions thanks to a new stent, Boston Scientific’s board wanted the company to diversify beyond its main business. Guidant had a good chunk of the lucrative market for pacemakers and implantable cardiac defibrillators, devices that shock the heart back into rhythm.

Guidant, in other words, looked like an attractive buy. But Boston Scientific wasn’t the only company to take notice, and, adding to the consternation, Johnson & Johnson looked like it was about to beat them to the punch. But as a J&J–Guidant deal was nearing completion, a patient with a Guidant defibrillator in his chest died. Guidant was forced to issue a massive recall and faced lawsuits and investigations. These developments led J&J to lower its offering price for the company. Undeterred, Boston Scientific pounced. It made an unsolicited offer for Guidant, which set off a bidding war.

Former executives describe what ensued as an all-out testosterone fest. They claim that Boston Scientific’s top brass became so obsessed with beating J&J that they failed to heed warnings that Guidant was a toxic asset. In the end, Boston Scientific spent $27 billion on a deeply troubled firm facing a mountain of messy litigation for alleged corruption and malfeasance.

In June 2006, less than two months after Boston Scientific closed the deal, it had to recall more of Guidant’s faulty defibrillators. The following April brought yet another recall. Boston Scientific had to shell out $296 million to the federal government after Guidant pleaded guilty to criminal charges related to its sale of defibrillators with deadly defects. The company has paid the feds $22 million more to settle charges that Guidant sales representatives gave kickbacks to doctors who bought defibrillators from the company. Boston Scientific has also spent $234 million to date to settle more than 8,000 claims from patients with Guidant devices. Two class actions and 37 more individual lawsuits await adjudication or settlement. In January of this year, the Department of Justice filed a civil lawsuit against Boston Scientific related to the problems with Guidant.

RANDEL RICHNER, the former vice president of global government affairs at Boston Scientific, says the company’s problems through the years have only been exacerbated by a “Wild West attitude” toward the regulatory agencies. “It was hard to convince the upper management that there needed to be a more proactive way to deal with the government,” Richner says. “We had the image of pushing the envelope, of snubbing our nose at authority. We were like a rebellious teenager. That attitude made us successful, but we needed to make a cultural shift when it came to working with agencies that were critical to our success.”

The FDA did not take kindly to this rebellious teenager. In early 2006, it issued a warning letter informing Boston Scientific that until the company addressed its quality-control concerns, the agency would not entertain new submissions for some of Boston’s products.

Jim Tobin, the man who’d succeeded Nicholas as CEO, spent a couple of years trying to fix this mess. Then, in 2009, the company unexpectedly announced his resignation, and Ray Elliott replaced him in July of that year. Elliott had made a name for himself by keeping investors rich and happy during his time as CEO of the orthopedic device maker Zimmer Holdings. He’d also been on Boston Scientific’s board. Elliott has said that he agreed to take the helm of Boston Scientific to help out “old friend” Pete Nicholas. The compensation didn’t hurt, either: Elliott earned $33.4 million in cash, stock, and options, making him the second-highest-paid CEO in America that year, according to Forbes.

Elliott came in with plenty of swagger. He was the new boss in town, he told his executives on numerous occasions. He took public shots at his competitors. He improved Boston Scientific’s long-term prospects by acquiring one company that was developing an aortic valve device, and another that had already come up with a device for asthma. The turnaround at Boston Scientific had begun, he
announced at every opportunity.

He also made it clear that he wouldn’t put up with any nonsense from his employees. During a call with analysts last year, he announced that he had “exited” from the company a few sales reps who “repeatedly breached our healthcare professional code of conduct.” Some of those people wound up getting hired by St. Jude Medical, a medical device competitor. Elliott knew what tends to happen when sales reps switch companies: Their accounts go with them. But it was the principle that mattered, he told investors. Boston Scientific could easily lose $100 million in sales by canning the reps, but, “We are going to run the company properly, and if we’re a somewhat smaller company short term or long term, so be it.”

Elliott also shelled out a total of $2.4 billion to settle 17 patent infringement lawsuits with Johnson & Johnson. To help pay down Boston Scientific’s $6 billion in debt, Elliott shed the company’s neurovascular division. He also laid off more than 1,000 workers.

But doing the right thing didn’t end up doing Elliott much good. Boston Scientific’s sales and share price continued to fall. The executive eventually admitted to analysts that the mess he’d found after taking over was greater than he had anticipated. Last year, for example, the firm lost $300 million in sales when it was forced to hold shipment of some defibrillators because it had failed to file paperwork with the FDA — an amateur blunder that Morningstar analyst Debbie Wang says never should have occurred at a major medical device maker. It not only cost Boston Scientific money and slowed its climb out of the hole, but it also indicated that the company was still having operational difficulties. “Sometimes I feel like the right hand doesn’t know what the left hand is doing at Boston,” Wang says. Elliott says that the paperwork issue was part of a “bad system we’ve since corrected.”

Pictured above, Ray Elliott, photo by Boston Scientific/Michael Malyszko.

IT’S STILL NOT ENTIRELY CLEAR why Ray Elliott resigned, but the move has raised the question of whether more bad news awaits. One Wall Street analyst says it’s hard to believe the company’s portrayal of the CEO’s departure as nothing more than the normal course of business. “It sounds hollow,” the analyst says.

Not all of the speculation has to do with Boston Scientific’s past. The same analyst points out that when Elliott announced his resignation from Zimmer Holdings, that move, too, was cast in rosy hues: He was going home after a job well done. Within months, however, the orthopedic industry was rocked after Zimmer and a few other companies settled a Department of Justice investigation into kickbacks allegedly paid to doctors.

Elliott says he left on his 10th anniversary of running Zimmer and that he had no idea about the DOJ investigation when he made his decision to resign. As to Boston Scientific, he says investors shouldn’t anticipate more bad news, since none is coming.

But internal problems are not the only challenges Boston Scientific faces. The world in which it operates has changed. Patient advocates, government investigators, and concerned doctors have made the public aware of some of the industry’s shadier practices. The kickbacks scandal at Guidant resulted in Boston Scientific agreeing last year to post on its website the payments it makes to physicians. And device failures and quality-control issues at Boston Scientific, and at other companies like Medtronic, have led to increasing calls for the FDA to tighten the approval process, which has slowed the pace at which new products get to market.

What’s more, it’s become evident that some medical devices have been overutilized. An academic study in 2007 found that doctors were grossly overusing stents, one of Boston Scientific’s core products. That report sent stent sales spiraling. Then, this past January, another study suggested that cardioverter defibrillators — Boston Scientific’s other core product — were also being overutilized by doctors. The Department of Justice is investigating why this might be. Defibrillator sales, too, are now down.

Add to all this the impending healthcare reform, which emphasizes cost cutting across the healthcare sector, and the medical device industry may be witnessing the end of an era. For Boston Scientific, it is a perilous time indeed.

None of which is to say that the company will implode any time soon. It has mended its relationship with the FDA and, in recent months, gained approval for two new stents. The company reported a small profit last quarter of $20 million, on revenue of $1.9 billion.

But the stock price at press time remained in the single digits. And famed hedge fund Paulson & Company, once Boston Scientific’s largest investor, has dramatically reduced its stake in the firm since 2010, shedding about 85 million total shares — while correspondingly upping its position in competitor Medtronic.

There are competing theories for why, exactly, Elliott left. But it just may be that, as one analyst puts it, “Boston Scientific is too fucked up to fix.” 

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