The Watson Plot Thickens, Thanks to the Message Boards

Also, Delia's deals and the closed-end fund jinx.
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My dear Mr. Watson:

Where's Sherlock when you need him? That's what yours truly would like to know when it comes to the case of

Watson Pharmaceuticals

(WPI)

, a rapidly growing Southern California generic drug maker that has been the topic of market rumors in recent days regarding

FDA

-related troubles. The chatter has its roots in a January "warning letter" the company received from the FDA regarding its main plant in Corona, Calif. It was the second time the company received the same type of letter regarding the same plant in 13 months. Issues this time around, according to the company's 10-K filed March 31, included "documentation, training and laboratory controls." The company shrugged it off as routine and said the issues are being corrected.

Routine is all in the eyes of the beholder. Details of the FDA's findings, obtained by this column from a source who got the FDA report through a

Freedom of Information Act

request, suggests the FDA isn't treating the issue so lightly. In a Feb. 1 memo, Virgilio Pacio, an FDA consumer safety officer, wrote that the FDA's investigative and compliance officials "expressed ... concerns about the compliance history of the firm and the reoccurring violations that would warrant further regulator actions." The memo added that Watson CEO Allen Chao wanted to know the "product impact" of the findings.

The product in question,

hydrocodone/acetaminophen

, the generic for the pain killer

Vicodin

, is Watson's biggest product. The findings in question involve the discovery by FDA inspectors of "unofficial/personal" notebooks being used by company chemists. Drug companies are required to keep official logs regarding the results of tests on drug batches. According to a so-called "Establishment Inspection Report" by the FDA, an FDA examiner noticed during a December tour of the plant "a personal composition notebook" on a benchtop. The notebook contained raw data and calculations.

According to the report, the notebook included data about rejected batches of the drug that weren't in the official FDA notebook.

Then yesterday (and this is where the story gets good) somebody posted an anonymous message on

Yahoo!'s

Watson message board that claimed to include the first page of a 118-page March 12 FDA report on Watson. (These reports are not routinely made public and can only be obtained through a Freedom of Information Act filing.) Other than "Watson" being spelled as "Warson," it included the actual case number and the correct numerical and alphabetic identifications of the same FDA examiners involved in the original report.

The purported report claimed that "the results of 10 failing raw material release tests were found recorded in uncontrolled notebooks or on notepads. These tests were repeated until passing results were obtained, and only the passing results were recorded in the official notebooks." If true, the report suggests the company wasn't fessing up to serious quality problems. (According to the company's own 10-K, the FDA has the authority to issue fines, demand recalls, suspend production, refuse approval of future drugs or even revoke previously granted drug approvals.)

I don't usually pay attention to message boards, especially anonymous posts. This one was brought to my attention by the same source who had obtained the original FDA report. Is it real? I asked Watson, and a spokeswoman said the company didn't know if the report was real. She only said that the company's chairman had seen the snippet for the first time on Yahoo, but "we have not seen any piece or part" of an original report. An FDA spokesman declined comment, suggesting I file a Freedom of Information request.

Yesterday Watson's stock dropped 3 13/16 to 41 3/4. In December, before word of the FDA investigation began leaking out, Watson traded as high as 62 7/8.

If the Yahoo! message is not true, it'll be yet another case of the danger of message boards. If it is true, it'll be yet another case of the danger of message boards.

Drilled by Delia's (or the games people play!):

So, a few weeks back this column's hostile React-O-Meter went spinning out of control after an item here questioned whether

iTurf

(TURF)

investors knew what they were getting from

Delia's

(DLIA)

, a catalog retailer geared to teenagers. iTurf was Delia's online unit, and Delia's was spinning off part of it to the public.

As part of the deal, iTurf planned to use as much as $13 million of the $42 million it had hoped to raise to buy stock in Delia's directly from Delia's. In other words, iTurf investors were also buying into cash-poor Delia's, which was using the iTurf IPO as a backdoor way to raise cash for itself. The column chided Delia's for not disclosing its fourth-quarter earnings to prospective investors in iTurf, whose audited results were included in the iTurf prospectus. "If iTurf investors are indirectly buying into Delia's, shouldn't they have a right to see the financial health of what they're buying? You would think," this column said at the time.

A week later, on March 30, the company issued a press release saying it was comfortable with earnings expectations for the fiscal fourth quarter, that ended Jan. 31. On April 9, iTurf started trading in the public market, getting the typical Internet multiple, with the stock of Delia's riding iTurf's coattails.

Then, yesterday, Delia's officially reported fourth-quarter earnings that were in line with analyst expectations. And, then, oh by the way, (you coulda, shoulda, woulda seen this one coming) it added that the first quarter will be lousy. So lousy that it said it is "revisiting" its forecasts for the year.

So, two weeks ago, when the company expressed comfort about fiscal fourth-quarter numbers, it either didn't know or neglected to point out that the current fiscal first quarter wasn't looking so sharp. And for good reason: Can you imagine how the IPO would've done if

that

kind of info were known at

that

time?

Delia's officials couldn't be reached.

Iomega insanity:

Iomega

(IOM)

reported its first-quarter earnings yesterday. The good news: The company made a small profit. The bad news: Revenues were $10 million shy. Even worse, instead of making the 10 cents per share analysts are expecting in the second quarter, the company is now guiding toward breakeven at best.

Closed-end fund curse:

A sign that Internet stocks are nearing the end of their latest run? Well,

Barron's

reported that

LaSalle Financial

is planning to bring to market a closed-end Internet fund within the next few months. And let's not forget that the IPO of the

Global Health Science

fund in January 1992 and

New Age Media Fund

in October 1993 pretty much called the top in those sectors for 18 to 24 months. "Both those funds produced negative returns for people who bought on the IPO for at least 2 years," says closed-end fund maven David Tepper, of

Tepper Capital

in San Francisco. "New music, same dance!"

But the beat goes on.

Herb Greenberg writes daily for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He welcomes your feedback at

herb@thestreet.com. Greenberg writes a monthly column for Fortune and provides commentary for CNBC.