With two regulators looking on, IR at life sciences companies is getting a lot more complex.
Unlike other heavily regulated industries in the US, the stakes seem more dramatic in the high-risk life sciences sector becauseit is under the watch of two federal regulators: the SEC and the Food and Drug Administration (FDA). ‘Biotechs are subject to more scrutiny than most companies because of the FDA,’ acknowledges Arthur Gabinet, district administrator of the SEC’s Philadelphia office. ‘Because biotech companies’ financial futures are so heavily dependent on the outcome of the FDA regulatory process, the two regulatory parts are on a collision course.’
Executives at VasoActive Pharmaceuticals may have assumed no-one really followed the FDA’s approval process when they began issuing a stream of statements about new medications they hoped to bring to market. The company said in its July 2003 IPO filing and other public statements that three treatments for athlete’s foot and arthritis had already received FDA approval for over-the-counter sales. VasoActive also claimed that ‘independent physicians’ at the prestigious New England Medical Center (NEMC) had supervised six-year trials of the new compounds and found them to be effective.
In both cases, as dismayed shareholders discovered, the truth was far less celebratory. In April 2004, with the share price already beginning to slide, the SEC abruptly halted trading for Massachussetts-based VasoActive, alarmed by what it described as misleading statements about FDA approval. This was only the beginning of the firm’s troubles.
A month later, shareholders filed a class action lawsuit, noting that none of the products had FDA approval. And the drug trials, they claimed, had not been performed by NEMC physicians but by a single podiatrist – who had been hired by VasoActive’s parent company, BioChemics.
With the plot thickening, VasoActive former president and CEO John Masiz last August agreed to settle the suit, paying an SEC-imposed $80,000 fine and accepting a five-year ban from serving as an officer or director of a public firm. The company never acknowledged wrongdoing.
Like VasoActive, some of the biggest names in life sciences have recently paid out in the multi-millions to settle criminal or civil suits based on violations of Regulation FD and other SEC rules. Schering-Plough and Bristol-Myers Squibb are among those that have been snared for violating basic fair disclosure rules.
Under the radar
While not all cases involve questions surrounding the FDA approval process, the SEC is particularly attuned to exaggerated prospects for a new drug or compound that willfully misleads investors and the public. To companies’ credit, however, the rules for compliance are confusing, making firms more vulnerable to SEC investigation. Often, experts claim, the founders of these companies – scientists or doctors with no business background – just don’t know any better.
‘Few companies want to cheat – it’s more often a difference of interpretation on reasonable disclosure or material information,’ explains physician and attorney Gregory Glover, a partner with Ropes & Gray who advises biotechs on their disclosure strategies. Regulations were drafted by lawyers, not research chemists, he adds. Often, scientists and doctors don’t apply the same focus to SEC filings as they do to the painstakingly detailed lab work they carry out.
At the same time, over-zealous business people can misinterpret the meaning or value of a preliminary FDA finding, leading them to issue a press release saying their product has been shown to have efficacy or promise in an FDA Phase I trial. But experienced researchers and investors know this is not newsworthy.
A fine line
It’s getting increasingly difficult for companies to paper over an honest misunderstanding or stupid mistake, however. Last year the SEC and FDA negotiated a memorandum of understanding allowing investigators to better cooperate. The two famously insular agencies have already collaborated on several SEC-initiated investigations, and observers say it could make more litigation almost inevitable as companies fall foul of one regulatory body while trying to please the other.
Of course, there are guidelines to help companies from committing the obvious mistakes. The first lesson, experts say, is not to disclose too little, or too much. If a company sends out a press release every time it hits a small milestone or receives some promising news, it’s setting a very communicative precedent it might be obliged to maintain.
‘The way the law works, unless there is an event in the life of a public company that is earthshaking, there is no need to discuss it,’ says Gabinet. ‘But once you talk you must keep updating the record so people don’t keep thinking the last public guidance is the latest and most definitive word on a situation.’
In other words, if a company trumpets its incremental triumphs, the investment community and the public reasonably assumes it will also acknowledge setbacks and uncertainties. In the case of biotech IR, it’s important to be aware that early disclosure decisions can be binding for a long time. Product development can take at least five years and tens of millions of dollars, so patience is the most valuable trait you can find in shareholders.
Former SEC enforcement specialist Elizabeth Gray, who is now securities defense attorney in the Washington office of Foley & Lardner, says one good way to get out bad news is to announce it in regular 10Q filings, along with any upbeat information. ‘That usually works, but be sure you can do it in a timely manner,’ she adds.
Avoiding temptation
In biotech, where only a fraction of ideas reach Phase III human testing, and only a fraction of those mature into profitable products despite the tens of millions of dollars invested in each, the lure of the quick hit can be too strong to resist for some company insiders. ‘You have no idea,’ says an exasperated Gray. ‘I tell my clients the SEC can easily build an insider trading case.’
Gray warns that federal authorities can track every stock trade during a finite period – for example, the days before a major announcement – and can readily investigate if they see something suspicious. ‘You have to put the fear of God into your people,’ she says, suggesting starting with a healthy wariness about computer messages. ‘E-mails are rarely benign. I advise all my clients to be prepared to see their e-mails on the front page of the newspaper.’
You might think investors in the volatile world of cutting-edge medicine would welcome all this oversight. You might think it would help them make informed decisions. But closer collaboration between the SEC and the FDA (not to mention the demands of Reg FD) is not making it easier for portfolio managers and analysts.
Even the most specialized biotech investors, who presumably understand the unique risks and roadmaps of the life sciences industry, shake their heads when it comes to deciphering the latest release from a company with a drug or device in the pipeline. A press release trumpeting the results of the latest phase of FDA testing could be desperate fakery, genuine misunderstanding or the real deal – there is no way of knowing.
‘The problem from an analytical standpoint is relying on what the company says,’ points out Buddy Lyons, senior vice president of research at Memphis-based Stanford Group. ‘The FDA is just a black box; we don’t know what it really said. In drug development, there are lots of euphemisms that are hard to clarify or nail down. As an analyst, I wish a lot of this could be verified. But you know the agency will never talk to you.’
Reg FD hasn’t helped Lyons out much. Since its passage in 2000, companies are putting out more press releases and public statements, but executives rarely venture beyond that. ‘They put out more statements but they’re not saying as much as they used to,’ Lyons complains. ‘Today, you can no longer speak to an executive candidly. We’ve got more information but it’s not as insightful.’
Gabinet thinks investors demand too much information, however. ‘Some of these equity analysts are like paparazzi waiting for Britney Spears!’ he laughs.
Looking ahead
It doesn’t look like things will get any better for IROs at biotech companies. Watchful regulators, ambitious scientists, increasingly cautious investors and a voracious media will continue to complicate these companies’ IR strategies.
Consider the case against Merck & Co, which was forced to withdraw popular anti-inflammatory drug Vioxx last October after it was found to contribute to heart attacks and strokes. The FDA contends the pharmaceutical giant knew for years about the side effects of Vioxx, a charge the company denies.
As patients scramble to find new treatments, advocacy groups are demanding the FDA create a new drug registry and post its own findings – and possibly those of the drug companies – on web sites. The information will, of course, be available to doctors and patients who want to read up on the statistics and case studies and make their own decisions about whether to gamble with a new product or prescription. But the data trove, presumably, will also be accessible to lawyers and investors. So the question is: what impact will this have on late-stage fund-raising and long-term investment?
Few life science companies are enthusiastic about the proposal and the industry trade group, the Biotech Industry Organization, is preparing to resist if necessary. Glover says companies must adopt standard operating guidance on what information to release and when, and how to do it. Too often, he says, the only preparation is procedural rather than tactical. ‘Most [FDA] information is proprietary,’ he observes.
IR needs to be aware the FDA and SEC are carefully scrutinizing communications. As Glover says, ‘The agencies are allowed to ask each other for clarifications – and the indications are that they’ll do it more often.’