A biotechnology stock, ImClone Systems of New York City, served as the root of Martha Stewart's insider-trading conviction, and life-science lawyers say that the biotech industry is ripe for more securities-related cases. Largely in response to the ImClone debacle, the US Food and Drug Administration (FDA) and the US Securities and Exchange Commission (SEC) initiated new policies that make it easier for these two agencies to cooperate on biotechnology cases. "Biotech has been hot for the last couple of quarters," says Darryl Rains, a lawyer in the Palo Alto office of Morrison & Foerster. "That raises the potential for disappointment. When you have unhappy shareholders, they will sue and attract the interest of regulators."
On Feb. 5, 2004, the SEC, which regulates public companies, and the FDA, which oversees the drug and medical device industries, announced an agreement to improve information flow from the FDA to the SEC. The agencies agreed to designate individual liaisons to the SEC within each of the FDA's centers, increase cross-training in securities and drug-law issues, and allow E-mail transmission of documents to improve the speed of information flow between the agencies. The FDA also agreed to streamline the way it shares nonpublic information with the SEC.
David Bayless, a former SEC district administrator in San Francisco who now defends life-science companies in securities cases at Morrison & Foerster, says the agreement to share information is an important new tool for the SEC. "Anything you file with the FDA can and will be used against you by the SEC," says Bayless. To keep track of other problem areas, see "Traversing the Trouble Spots".
Coleen Klasmeier, special assistant to the chief counsel of the Food and Drug Division of the Office of the General Counsel in the US Department of Health and Human Services, says that the agreement came about as part of a regular review of interagency relationships. She adds, however, that the ImClone fallout, including two Congressional hearings that focused on FDA policy, played a part. "It really was just time, but of course the ImClone episode caused us to think carefully about what we could do on our part to contribute to the larger corporate compliance efforts the administration has undertaken," she told a Food Law Institute audio conference in March on the new SEC-FDA cooperative agreement.
Klasmeier says the FDA-SEC agreement will standardize reporting procedures for FDA employees. Previously FDA staff could approach the SEC when they thought there might be a problem with a company's disclosure. According to Klasmeier, some employees were more interested in this than others. "We want there to be just the right amount of consciousness about securities issues – no more, no less." In addition, Klasmeier believes that better disclosure may aid the agency's public-health mission in targeting limited investment dollars to legitimate companies. "We want those dollars to go to the right places, not to companies that are touting vaporware," she says.
COMPANIES UNDER INQUIRY
John Heine, a spokesman for the SEC, says that the new agreement has not triggered a sharp rise in cases. So far, the SEC filed only two new cases involving life-sciences companies. In April, the SEC ordered the suspension of trading in shares of Vaso Active Pharmaceuticals of Danvers, Mass., for allegedly making misleading statements about FDA approval of products. In subsequent lawsuits, shareholders contend that the company issued false information about clinical trials of its athlete's foot cream. The company says that it is working with the SEC to resolve any problems. In May, the SEC also announced administrative proceedings against Ocumed Group, an ophthalmic-products company in Roseland, NJ, to determine if the agency should revoke or suspend Ocumed's registration for submitting an allegedly forged audit in 2002. Ocumed declined comment.
"Obviously the FDA has its own functions to perform, and nobody is suggesting the FDA is going to become the securities watchdog of the drug industry. But the fact that there's now a commitment to proactivity and an enlightenment on the part of both agencies to the needs both of them have, I think, makes this quite significant," says Harvey Pitt, former chairman of the SEC, who also spoke during the Food Drug Law Institute audio conference.
Bayless points out that the SEC's office in San Francisco has grown from 40 attorneys to 90 and could increase to 120. "They're looking for targets because they have mouths to feed,"he says. In addition to the cases filed since the SEC-FDA agreement went into effect, the SEC has a number of active cases against biotechnology and pharmaceutical companies.
Biopure of Cambridge, Mass., is under investigation for the way it disclosed information about the approval process of its experimental blood substitute, Hemopure. During the spring and summer of 2003, Biopure's stock rose as company officials described progress. Meanwhile, the FDA blocked the company from conducting a trauma trial because of safety concerns. FDA communications with companies are kept secret, but on Dec. 24, 2003, Biopure disclosed the trauma trial news, arguing that it failed to mention the information because the trial never started. Stock shares plummeted.
Amylin Pharmaceuticals of San Diego is under informal investigation by the SEC. In a private call to investors, Amylin officials allegedly disclosed that the FDA declined to approve Amylin's diabetes drug, Symlin. Later that day, after stock markets closed, Amylin released the information to the public.
For many biotech companies without revenue or profits, information is about all that they have to sell. Often, progress is slow and companies are tempted to highlight any advance, which could lead to disappointment later. "The increased collaboration between the FDA and SEC on this really requires life-science companies to be more sensitive to accuracy and timeliness, and avoiding unjustified puffery," says Stanley Keller, a lawyer with Palmer & Dodge in Boston. Further, he says he believes that biotech executives often find it hard to judge the importance of an FDA decision, much less communicate it quickly to shareholders. "Often the information that companies receive from the FDA is, at best, inscrutable," he says.
ATTORNIES ON ATTACK
Besides the SEC and the FDA, companies must watch other authorities, too. State attorneys general – particularly New York's Elliott Spitzer – are taking an increasing role in shareholder litigation. "When they see the FDA and the SEC is involved in something like this, it would be naïve to think that each of these attorneys general are not thinking, 'Hmmmm, I wonder how I could be involved?"' says Alan S. Goldberg, a partner at Goulston & Storrs in Washington, DC.
Class-action attorneys also hunt for disclosure problems. Fred Isquith, president of the National Association of Shareholder and Consumer Attorneys, indicates that biotech companies can get into trouble when they are desperate for cash. "They wake up and realize they're running out of money. The natural inclination is to exaggerate your success, puff up your business and brag about how well you're doing," says Isquith. "You can move quickly over the line if you don't have money."
Even private companies should worry about disclosure, says Keller. Most biotechnology firms eventually plan to go public and need to be careful about statements in the months before that.
In addition to prison sentences and fines, failure to follow disclosure rules can have other costs, says Rains. Many companies are forced to settle shareholder suits because it is cheaper than litigating. A disclosure problem also may make it expensive or impossible to insure executives. Finally, a smear on a company's reputation with investors can damage future fundraising.
According to Rains, companies hire expensive attorneys to ensure that their official SEC filings are in order, and then get in trouble with off-the-cuff comments. "Everything you say is going to get scrutinized," he says. "By everything, that includes more casual statements to newspapers, statements at medical conferences, even statements on your Web site. All of those statements should get the same careful scrutiny and preparation as an SEC filing."
TRAVERSING THE TROUBLE SPOTS
Life-science companies face at least six trouble spots with securities disclosure. Attorneys at Morrison & Foerster in San Francisco provide this list of problem areas and advice.
Don't overstate Phase-II results. Remember that those results involve limited data. Be prepared for volatility and speculation in the stock after an announcement.
Disclose promptly to avoid insider-trading risk. Synchronize public and scientific disclosure. Make scientific disclosures publicly available.
Predicting FDA approval
Avoid predicting the timing or certainty of FDA approval. Use safe-harbor or forward-looking statements in any press release. Prepare and train executives for questions from the media. Regularly update disclosure of risk factors and safe-harbor statements.
Serious adverse effects
When describing adverse effects avoid qualitative words such as severe, serious, or significant. Disclose numeric trends in key indicators. Be specific and quantitative.
Clinical trial design
Describe specific milestones and let the audience draw any conclusions. Be quantitative. Refer to objective facts. Don't predict regulatory action.
Know why you are disclosing patent information. Are you willing to say what the patent is not? Describe a patent specifically by its claims. Disclose patent risk, such as other pending applications.