The Dragon That Cost Investors Millions

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Investors got a little more information yesterday about Sequenom's (Nasdaq: SQNM  ) "employee mishandling of R&D test data and results" for its revolutionary blood test for Down syndrome that occurred last year. The Securities and Exchange Commission filed a complaint against Elizabeth Dragon, the company's former Senior Vice President of Research and Development.

Turns out it's something we all learned in high school: It's a lot easier to score high on a test if you already know the answers.

When companies are validating tests, the person running the test isn't supposed to know how the sample turned out -- in Sequenom's case, whether or not the mother had a baby with Down syndrome. But the SEC says that Dragon told researchers the results, which helped them interpret the complicated results to come up with the right answer. That would be O.K. if they were in the development stage for the test, but the SEC says Dragon included those gamed results in the data presented to investors, which gave the illusion that the test was nearly 100% accurate.

Her punishment for allegedly pumping up the stock and then sending it down 76%? She's barred from serving as an officer or director of a public company, and there will be a financial penalty set at a later date. Doesn't seem strict enough to me.

So what does the new information mean for current Sequenom shareholders? Well, shares have responded well -- up 10% or so -- now that a bit of the uncertainty surrounding the company has cleared away.

Beyond that, it's a little hard to say. Bad things happen to companies all the time: Johnson & Johnson's (NYSE: JNJ  ) and Genzyme's (Nasdaq: GENZ  ) medicine manufacturing problems, BP's (NYSE: BP  ) oil spill, and Toyota's (NYSE: TM  ) acceleration issues are all recent examples. But unlike those issues, which the companies should be able to resolve if they throw enough money at them, it's not as clear whether Sequenom's test will ever work to a high enough degree to be useful.

Sequenom's sex-determination test is on the market, using the same basic system of isolating the fetus' genetic material from the mother's blood. But testing for the presence or absence of a Y chromosome seems to be less challenging than testing for the presence of an extra copy of chromosome 21, which causes Down syndrome.

No one will know for sure if the Down syndrome test works until Sequenom completes its studies of the test sometime next year. Given the history of the company, investors should be very cautious about investing, even if the Dragon lady no longer works there.

The moral of this story is one that Rich Greifner already learned: Don't put all your eggs in one basket.

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Fool contributor Brian Orelli, Ph.D., doesn't own shares of any company mentioned in this article. Johnson & Johnson is a Motley Fool Income Investor selection and Motley Fool Options recommended buying calls on the stock. The Fool has a disclosure policy.

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