Times "Selling Drug Secrets" story commentary
piece published August 7, 2005, Seattle Times reporters Luke
Timmerman and David Heath report the results of a months-long
investigation into insider trading in the biotechnology sector. Their
investigation uncovered a distressingly common practice of doctors
accepting payment in return for providing inside information on ongoing
and unpublished clinical trials. This practice is so common, several
multi-million dollar businesses exist solely to service hedge funds who
wish to interview doctors for information.
indications are this story will cause quite a splash, so we wanted to
take some time to provide our Subscribers and other interested parties
with our thoughts on the subject.
Loss of investor confidence
We have written at
some length previously how the biotech sector is particularly reliant on
investor confidence. Development-stage biotechnology stocks have no
revenues and, therefore, very little in the way of financials investors
can use to perform traditional valuations. Analysis of the science,
diligent tracking of the company’s progress, and an unusual amount of
faith are necessary to be an investor in these companies.
accepted cash in return for providing inside information
And investing in these
companies is important. Without the billions in equity provided by
investors via the purchase of common stock and convertible debt, these
companies would have no way to perform the ground-breaking medical
research to create new treatments for cancer, macular degeneration,
diabetes, pain relief, degenerative diseases, and more.
With only one of ten
biotech companies actually succeeding, biotech investors already have a
tough row to hoe. It is likely investors who have faced losses in the
sector (as all have) will be discouraged by the Seattle Times
investigative report. The article makes it clear the playing field is
not level and that those with financial resources can purchase inside
We expect some
investors – particularly individual investors – will lose confidence in
the sector unless the SEC and other regulatory agencies make definitive
claims the week of August 8 that they are launching
investigations into this matter. Any loss of confidence will not just
harm valuations in the sector, but any significant flight of capital
will harm medical research in the long term.
Doctor consulting is not
We need to draw a
distinction here. We have no problem compensating doctors for time taken
to discuss scientific principles, clinical trials, and other information
provided the discussions are limited to reported
data or the use of drugs already on the market. In fact, we believe
doctors should be encouraged to speak about completed clinical trials
whose data has already been made public. Their opinions serve as an
excellent check and balance against management teams who can be too
promotional for the good of their investors. And nobody wants to muzzle
doctors who believe a marketed drug has safety problems.
no problem compensating doctors for comments on trial data already
We will go one step
further and make the declaratory statement that any regulatory action or
decision by internal ethics boards that prohibits doctors from talking
about studies already made public would be dangerous, ill-advised, and
completely missing the point of the Seattle Times article.
The disturbing finding
of the Seattle Times investigation is how blithely doctors
exchanged insider information for monetary compensation. In one case, a
doctor had membership on a trial safety committee which provided him
access to all unblinded information in the unreported trial. Not even
the company sponsoring the clinical trial has access to that
information. His conversations about that drug and those unreported data
were wholly inappropriate. The fact he got paid makes the situation all
the more egregious.
How to solve the problem
The SEC needs to
address the development-stage biotech sector’s unique challenges quickly
and with considered authority. In April of this year, we sent a letter
to then-Chairman William Donaldson describing the selective disclosure
that occurs because management teams are prohibited by scientific
organizations from releasing material information to their own
shareholders. This issue of selective disclosure is an easy one to
address and we suggested four short amendments to Regulation Fair
Disclosure that would solve the problem.
The issues raised by
the Seattle Times piece are more difficult. There are, of course,
already rules in place to prevent the sharing of inside information. The
SEC should enforce those rules vigorously. They should also begin a
dialogue – separate from the Regulation FD matters mentioned in our
April letter – to develop guidance clarifying the difference between
illegal communication of insider information and beneficial
conversations about clinical data that has already been reported to
The SEC should begin
its investigation immediately to prevent the “loss” of important
information linking the access of inside information with trading
activities at hedge funds and NASD/NYSE registered firms. Particular
attention needs to be paid to the timing of analyst research, changes in
trading flow from major clients, options activity, options expiration
dates, selective disclosure to preferred clients of this insider
information, and the dates of conversations with doctors in possession
of inside information.
Ethics Boards of
academic institutions are certain to become involved in this discussion.
We will make this open offer right now to doctors and researchers:
If your institution is considering a blanket ban on conversations with
investors, contact us. We will take the time needed to have as many
conversations as necessary with members of your Ethics Board to help
them understand the difference between insider trading and rigorous
vetting of scientific data once it is reported. The medical profession
and, frankly, our society are extremely capable of drawing fine
distinctions between proper and improper behavior. There is no need to
abandon that capability in this situation.
institution is considering a blanket ban on conversations with
investors, call us.
Investors have a more
difficult decision. On one hand, the activities uncovered by Mr.
Timmerman and Mr. Heath make it clear the field has been stacked against
individual investors for at least the last 12-24 months. As an investor,
you need to make the decision how to proceed. Should you leave the
sector and look for opportunities elsewhere? A recent Business Week
article noted one of the companies facilitating this scandal also hooks
hedge funds up with insiders in other industries. This suggests perhaps
you’d have to leave equities altogether to escape this behavior.
We won’t speak to other
sectors for now. Where biotech is concerned, the data are the data. We
know from experience the information obtained from doctor interviews –
interviews we do, but do not pay for – that doctors’ predictions are not
always correct. In many cases, they have seen only a small percentage of
the patients on a trial and their experience may not be relevant to the
entire trial’s outcome. While there is no question this pattern of
paying doctors for inside information has harmed companies and
investors, in the end the data will arrive intact and additional
judgments on the worth of the company can be made at that point.
The silver lining
The Seattle Times
story presents an exceptional opportunity to drive important investment
reforms. Accounting scandals drove important new legislation and this
scandal is at least on par with those issues. Individual investors and
principled professionals who know the current state of affairs is not
sustainable should take a few minutes and express their thoughts on the
Seattle Times article to their Congressional representatives and
Good will come of this
story for biotech investors. We cannot fathom a reaction to this story
that will let the current state of affairs continue unchallenged.
Choking off this type of inside information may reduce unexplained
volatility in the sector and restore some badly-needed balance between
both sides of the trade. Such a shift will not happen overnight and it
will not limit the exceptional risk inherent in biotech investing. What
it will hopefully do is make things more fair and there
are tangible benefits to that.
We would like to
applaud Luke Timmerman and David Heath for doing the considerable
legwork necessary to bring this story to light. We would also like to
commend the editors of the Seattle Times and the Knight-Ridder
chain for their editorial integrity in publishing this story and their
commitment to providing it wide exposure.
This is a bittersweet
day for the sector our firm has chosen to study. The extent of the
insider trading is discouraging, but the fact it has been brought to
light so thoroughly holds significant promise.
We are uncertain of
both the effect of this story on the sector and, frankly, on our own
business. Where the latter is concerned, we would hope it underscores
the necessity for independent research in a market overly burdened by
conflicts of interest. Where the former is concerned, we hope for the
sake of patients everywhere Wall Street has not burned the bridge
between investor cash and the advances in medical science made by
development-stage biotech companies. Good will come of this provided the
SEC, Congress, and individuals stay focused on addressing the problem
via smart rulemaking and legislation.
If you have thoughts on
the matter, in addition to sharing them with your representatives in
Congress I’d like to hear them at
- David D. Miller
- Biotech Stock Research, LLC