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The most intriguing question about

American Pharmaceutical Partners

(APPX)

is who will benefit most from the business: Chairman and CEO Dr. Patrick Soon-Shiong or its outside shareholders?

The question arises because of the two, sometimes competing, executive hats worn by Soon-Shiong. He is the 80% owner, president, CFO and chairman of a private firm,

American BioScience

, which, in turn, owns 69% of American Pharmaceutical, a seller of generic injectable drugs. Simply put, Soon-Shiong controls both companies -- one public, the other private.

This structure still wouldn't raise too many eyebrows if it weren't for the fact that American Pharmaceutical and American BioScience also are in business together, to develop a new formulation of the cancer drug Taxol. Under this arrangement, tens of millions of dollars of American Pharmaceutical cash -- raised from investors -- is flowing directly into the coffers of American BioScience.

American Pharmaceutical makes no secret about these facts, insisting that measures to protect against conflict of interest are in place. Shareholders will benefit in the long run if and when this new form of Taxol, dubbed ABI-007, is approved and commercialized, the company adds. But is enough revealed about these less-than-arm's-length deals to make shareholders comfortable? The answer, according to company critics and some shareholder rights activists, is no.

That is one of the reasons why short-sellers have targeted American Pharmaceutical, which they see as simply a cash machine for Soon-Shiong and American BioScience. To these critics, who have borrowed against 47% of the freely traded shares, everything about this arrangement favors Soon-Shiong, leaving outside shareholders holding a very short straw.

As one short-seller in American Pharmaceutical describes it: "This is the kind of eye-popping deal where even if investors think they're winning, Soon-Shiong is winning more. And if investors lose, Soon-Shiong still wins."

American Pharmaceutical officials see it much differently. They insist all the details concerning the deep and interlocking relationships among the company, CEO Soon-Shiong and American BioScience are disclosed in filings with the

Securities and Exchange Commission

. They say the company has engaged in a rigorous practice of full public disclosure, and no issues or problems with its corporate structure have been raised by its outside auditors or U.S regulators. They maintain that American Pharmaceutical investors benefit from this arrangement.

"None of this is kept secret from investors, and no one is holding a gun to their heads making them invest in our company," said Lou Phelps, a spokesman for American Pharmaceutical. The company would not make any of its top executives, including Soon-Shiong, available for comment.

Back to the Beginning

To really understand this story, you have to go back to November 2001, when American Pharmaceutical (then a private company controlled by Soon-Shiong) acquired the exclusive North American rights to market and sell the new, yet experimental, Taxol formulation, known as ABI-007, from American BioScience. The upfront license fee for this deal was $60 million.

The following month, American Pharmaceutical went public, raising about $134 million in net cash. The timing of the initial public offering was fortunate, because American Pharmaceutical paid the $60 million upfront license fee to American BioScience in January 2002.

Given that American Pharmaceutical essentially transferred 44% of the money raised by shareholders and gave it to a private firm controlled by CEO Soon-Shiong, you'd think that these shareholders would deserve a detailed explanation of how this deal came about. Most importantly, how was the $60 million licensing fee for ABI-007 set? And was an outside expert brought in to determine whether this insider deal was fair and equitable?

This is where things get a little fuzzy. American Pharmaceutical says an independent consultant was hired to analyze the deal, or in Wall Street parlance, issue a fairness opinion. This consultant's conclusion: The $60 million licensing fee, plus all the other terms (more on those later) were fair.

Who was this consultant hired by American Pharmaceutical? The company won't say. Has the fairness opinion been publicly disclosed? The company says no, mainly because disclosure of the fairness opinion is not required. It declines to offer any additional details.

This kind of selective disclosure is troublesome to Beth Young, an attorney and director of special projects for the Corporate Library, a shareholder rights research group.

"A company can't disclose the bare minimum about a conflict, provide no details, and then expect shareholder concerns to be allayed," Young says, adding that in her experience, there is no reason why fairness opinions should not be filed alongside licensing agreements or any other type of deal, especially deals in which possible conflict of interest issues are readily apparent.

American Pharmaceutical did make public the terms of the actual license agreement with American BioScience, attaching it to a December 2001 stock registration statement filed with the SEC. The accompanying fairness opinion, however, is not included.

American Pharmaceutical also said it had four outside members of its board of directors review the American BioScience transaction specifically to make sure the deal was agreeable to all shareholders and did not unfairly favor Soon-Shiong. But in fact, two of these independent directors had close financial ties to American Pharmaceutical when the licensing deal was approved. This raises questions about their status as outside, independent directors, according to certain, more stringent, corporate governance standards.

Ann Rhoads was one of these directors, serving from May 2001 until October 2002. But Rhoads is CFO of

Premier Inc.

, one of the largest purchasing groups in the health care industry. Premier was a seed investor in American Pharmaceutical and owned more than 7% of the company's stock when it went public. American Pharmaceutical also was required to hand over a percentage of revenue to Premier that hospitals paid to buy its generic drugs.

The relationship between Rhoads' employer and American Pharmaceutical puts her outside the definition of independent director used by the Council of Institutional Investors, whose membership includes many of the largest public and private pension funds in the country. Rhoads could not be reached for comment.

(As an aside, in March 2001,

The New York Times

published a revealing, troublesome story on the relationship between Premier and American Pharmaceutical. The story was part of an investigative series that won a George Polk Award last month.)

The status of director Frank Kung, who served on the American Pharmaceutical board as an outside director from 1998 until 2002, is less clear. He's a venture capitalist, and one of his funds purchased preferred shares in American Pharmaceutical in a 1998 private placement. That investment was converted into a post-IPO ownership stake of more than 2.8 million shares, or more than 7%.

The Corporate Library's Young says Kung falls into a gray area of independence. His firm likely received preferential treatment from American Pharmaceutical as a result of the private placement, but on the other hand, his relatively large ownership stake in the company could align his interests with other outside shareholders.

Kung said his status as an outside or inside director of American Pharmaceutical depends on which definition you use, but he's sure that the entire board of directors scrutinized the deal with American BioScience to make sure it was equitable to all shareholders.

"I wouldn't have voted for the deal if it wasn't," he said. Kung also said that while he's sure the company brought in outside consultants to offer an independent assessment of the deal, he doesn't recall whether a fairness opinion, in the strict legal sense, was obtained.

American Pharmaceutical spokesman Phelps says all four outside directors were independent and acted in the best interest of all shareholders. Rhoads and Kung have been replaced on the company's board with two new, independent directors, maintaining a balance of four outside directors to three inside directors. Outside directors review all transactions between American Pharmaceutical and American BioScience, Phelps adds.

The controversy over the tight-knit relationship between American Pharmaceutical and American BioScience has meaning for investors because the transfer of money from the public company to the private firm will continue. Under the drug licensing agreement, American BioScience is responsible for the testing of ABI-007.

A Critical Look

Critics of American Pharmaceutical, including short-sellers, believe the company is actually footing the bill for the development of ABI-007. As evidence, they point to a $23 million outstanding loan to American BioScience, proffered by American Pharmaceutical around the same time as the licensing agreement was struck. Details of the loan are included in multiple quarterly reports filed to the SEC by American Pharmaceuticals.

The loan, presumably, could have been paid off with the $60 million proceeds, but, in fact, the loan amount continues to grow and includes, among other things, costs related to "new product development (principally related to ABI-007)," according to American Pharmaceutical's last third-quarter 10-Q filed with the SEC.

American Pharmaceutical spokesman Phelps confirmed that about $14 million of this loan is used to help American BioScience pay for the development of ABI-007. But at the same time, Phelps says interest accrued on the loan actually benefits American Pharmaceutical shareholders.

ABI-007 is currently being studied in a phase III clinical trial of patients with metastatic breast cancer. Results and a regulatory filing to the Food and Drug Administration are expected later this year, according to American Pharmaceutical. (The study and the drug's regulatory timeline will be addressed in a future column.)

Furthermore, American Pharmaceutical is accounting for the $23 million loan as a deduction from stockholders' equity, an accounting strategy that keeps the true costs of ABI-007 off the company's income statement. That raises the question of whether American Pharmaceutical is using American BioScience as an off balance sheet R&D vehicle, which hides the cost of developing ABI-007 and allows artificial inflation of the income statement.

Phelps defends the loan and accounting treatment, saying it's all been disclosed to investors and given a green light by the company's outside auditors, Ernst & Young.

If the $60 million upfront licensing fee for rights to ABI-007 and the $23 million loan weren't enough, American Pharmaceutical and its investors are under contract to pay a whole lot more to American BioScience (and its 80% owner Soon-Shiong -- remember he's also the president and CFO of American Pharmaceutical) for the drug's development and possible commercialization: These payments include:

$60 million for indications related to breast, ovarian and lung cancers;

$32.5 million for indications relating to prostate cancer;

$110 million related to the achievement of certain sales goals.

Also, profits from ABI-007 are split 50-50 between the two companies.

In other words, a heck of a lot of American Pharmaceutical money is going to flow down to American BioScience before American Pharmaceutical shareholders see any sign of a return on their investment.

The company says this is disclosed and fair; shorts call it a one-sided, raw deal. Ultimately, it will be up to investors to decide.

Adam Feuerstein writes regularly for RealMoney.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks, although he owns stock in TheStreet.com. He also doesn't invest in hedge funds or other private investment partnerships. He invites you to send

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