The first lesson in IR 101 is ‘no surprises.’ Would investors be surprised to find out that the eminently respectable scientists whose published research they are reading have stock options whose value hinges on those results?
It is mostly in the biotech and pharmaceutical fields that scientific papers have financial implications. Many companies either circulate reprints to investors, or at least point them out to analysts. The scientists from long-established companies like Genentech or Cephalon can publish a research paper a day without too much market effect since the blue-chip papers for them are about successful clinical trials. However, for start-ups, even early research papers can be pure gold – that research may be the only asset they have.
According to Genelabs IRO Debra Bannister, ‘Getting published is critical to moving your science forward. For a biotech company that has no product on the market, it is one way that investors can evaluate the science. Then they know, even if they are not scientists themselves, that other scientists have reviewed the work.’
Start-ups have their own special problems, as Bannister points out. ‘If you’re talking about clinical tests with humans, where most of the work is done by outsiders, then they have to be compensated and it’s difficult for a non-profitable biotech company to come up with significant amounts of cash. To pay, they use stock, and it’s accepted in biotech. That’s pretty much how you pay everybody – even the landlord,’ Bannister laughs. But she adds on basic IR grounds, ‘Of course there should be disclosure.’
If the journal in question does not have a disclosure policy regarding the authors’ financial interests, then the connection may not be too apparent to some unwary investors. At one time, analysts and investors within the biomedical field studied the literature on their own account, and they were often scientifically qualified. Just as it is often assumed with financial analysts’ recommendations, everyone knew the scientists often had a financial interest. However, with the exponential growth in the number of active retail investors, that presumption, either of erudition or due diligence, can no longer be taken for granted.
Keeping mum
In that case, how much disclosure is there? Professors Sheldon Krimsky of Tufts University and Leslie Rothenberg of UCLA looked at over 60,000 articles in the biomedical field, and found that only just over half a percent disclosed any author’s financial interest in the results. Only five biomedical journals insisted on their authors declaring any financial interest in the results of their papers – and some 13 percent of their authors do declare their financial interests when published.
Leading by example, Krimsky and Rothenberg carefully disclose the source of their funding for their own research. In contrast, Krimsky says that in a separate investigation of 800 scientific papers conducted two years ago, he discovered that some 34 percent of authors had conflicts of interest – and that not one of these had disclosed.
‘We have the sense that there have been specific instances where these published reports in medical or scientific journals have been used to hype IPOs or the stock in existing companies. Venture capital people get approached on a very preliminary basis with research papers,’ says Rothenberg, cautioning that a financial interest ‘doesn’t invalidate their research, but it does mean that there is a risk, consciously or unconsciously, of them hyping their results, not just for the usual reasons academics do that, but because they have a financial interest.’
Rothenberg adds with world-weary facetiousness, ‘It’s getting so that everyone has a financial interest, and so that will become the default. People will only indicate when they don’t.’ Indeed, the days are gone when scientists toiled in drafty attics for the sake of knowledge. Today’s researchers expect to get their financial rewards in advance and in excess of a Nobel prize; they are certainly not waiting for arrival at the pearly gates.
Research is expensive, and the rewards and penalties are both high. For example, Cephalon spent $180 mn in developing Myotrophin, its drug against Lou Gehrig’s disease – and its stock plummeted from $30 to $12 when a Food & Drug Administration (FDA) advisory panel reported adversely on it. If the final FDA approval comes through then it will doubtless shoot back up again.
Hot cold medicine
Conversely, the Quigley Corporation is still pouring out its Cold-Eeze zinc lozenges onto an eagerly-waiting market, based on two 1997 studies of their effect on the common cold. At the time, Quigley’s stock soared from a lowly 62 cents to $32.
Only this July, Quigley poured cold water on another company’s anti-cold nostrum while claiming proudly that Cold-Eeze ‘has been proven to reduce the severity and duration of common cold symptoms in two double-blind, placebo-controlled studies,’ even though the author of one of those studies said himself that some more tests were necessary.
The Securities and Exchange Commission has not directly considered the question of disclosure in connection with scientific research, although commission spokesman John Heine is prepared to ruminate that, if the primary purpose of such a research paper was to tout a certain stock, then it might well be covered by the 1933 Securities Act’s strictures which pertain to disclosure in circulated publications. The Securities and Exchange Commission has already made it perfectly plain that it frowns upon the circulation of financial analysts’ reports by the subject companies. Is the circulation of scientific papers with possible financial outcomes so different from that?
Gravy train
Certainly some investors are getting concerned. Money manager David Tice has worked with biotech companies. ‘I know some companies that have had new drugs and my own mother-in-law found out that a lot of the people involved in the research were stockholders,’ he recounts. ‘I shorted one as a result,’ he adds.
Tice believes such matters should be disclosed. ‘These scientists are reading about Bill Gates and his stock options and then they’re being told – we’re paying you in options. It’s obvious that this is their gravy train, their chance to get rich. They know what results they’re expected to come up with. Even if they declare they’re getting options, I may still short them, but at least I’m glad that they’re honest about it. If you have to dig, then it becomes almost a fraud situation.’
From the safe haven of a long record in the market, Genentech investor relations officer Susan Bentley confesses, ‘I’m actually shocked to hear that it still goes on. Maybe it’s just the caliber of the publications we publish in, but they do have disclosure. I know a lot of companies proactively send out papers. I don’t. We publish a paper a day on average, in journals like Nature, or the New England Journal of Medicine. If an investor calls and requests a paper, and if I have access, then I’ll send it as courtesy. But if companies are proactively sending them out on a routine basis, then they should consider disclosure.’
Indeed the SEC took action for insider trading against an outside researcher for Cephalon who bought up stock based on favorable results about Myotrophin that had not yet been made public. He made $25,000 on his trades and even the graphic designer who was preparing the slides showing the results made $50,000.
Scott Melville, Cephalon’s regulatory attorney, points out that the company was not implicated in those cases since clinical trial agreements with investigators stipulate that ‘they shouldn’t buy or sell or trade Cephalon stock while they are in possession of material non-public information – and clinical trial results before they’re made public are very material information. The agreement was in place with vendors – including the slide preparer in that case.’
‘Taking compensation for research does not necessarily mean that the research is biased, but disclosure is important,’ Melville agrees. Indeed, he points out that the Food & Drug Administration has stolen a march on the Securities & Exchange Commission with its latest guidance asking clinical investigators to certify that they do not hold more than a certain level of interest without the company disclosing it. It specifies a limit of $50,000 equity holdings for a researcher, during and for a year after the research, while also insisting on disclosure of any other financial interest in the results.
However, the Food & Drug Administration strictures only apply when it comes to marketing the product. Marketing the stock, which happens at an earlier stage of the procedure, is the province of the Securities & Exchange Commission. Interestingly, in their arguments about why their disclosure rules did not abrogate rights to free speech, the FDA invoked numerous SEC cases to establish that the public interest in regulation over-rode the first amendment. Can it be long before the SEC closes the loop and emulates the FDA?
