Gregory Bull / AP

Betting on biotech: Activists want SEC to regulate volatile market

Selective prosecution, regulatory loopholes and mercurial industry stocks create hectic investor conditions

Even by the standards of the New York Stock Exchange, the biotech industry is a particularly volatile investment market. News of positive results from a clinical trial can send an unknown company’s stock skyward. Negative results send others swiftly into bankruptcy. Small startups worth only pennies per share can triple their value overnight with a successful drug.

The recent experience of one biotech firm — Vertex Pharmaceuticals, whose stock price has seesawed dramatically — has become a symbol of more than just the biotech market’s volatility. Critics and activist shareholders say it is also emblematic of lax regulation by the Securities and Exchange Commission (SEC).

The SEC has been accused of failing to adequately investigate numerous trades by Vertex insiders that reaped millions of dollars of profits for its executives and appear timed to have taken place before announcements of negative news. The claims, which came amid a flurry of lawsuits, have brought into focus criticism that the SEC is underfunded, too reluctant to investigate firms with rising stock prices and opaque in its decision-making. They have also thrown a spotlight on an apparent loophole in the law that allows executives to make controversial trades just before bad news about their firms breaks.

Bart Naylor, a financial policy advocate with watchdog group Public Citizen, said that the SEC “only catches a small percentage of Wall Street mischief because it is outmatched in resources and only goes after easy-to-win cases.” He thinks Vertex epitomizes many of the problems the regulator has in policing the biotech market.

The Vertex story is a complex one. When Vertex announced results of clinical trials for its new combination therapy to treat cystic fibrosis in March of 2015, it was not good news. Outcomes for patients who took a mixture of the cystic fibrosis drug Kalydeco (ivacaftor) with another Vertex drug, VX-661, were not as positive as many had hoped. There was only a 3 percent improvement in patient health compared with those given a placebo. After announcement of the news, the stock tumbled almost 6 percent.

Right before the announcement, executives in the company sold off over $4 million in shares. The timing of the stock sales appeared suspicious. If executives of the company knew about the mediocre results of the clinical trial and traded on the information before the public knew about it, their actions would be considered insider trading under the Securities Exchange Act of 1934

‘[The SEC] only catches a small percentage of Wall Street mischief because it is outmatched in resources and only goes after easy-to-win cases.’

Bart Naylor

financial policy advocate, Public Citizen

Vertex first came to prominence in January of 2012 when the company’s drug Kalydeco was approved to treat a small subset of cystic fibrosis sufferers. Since then, Kalydeco has regularly been referred to as a miracle drugwonder drug and the most important drug of 2012 in the media for making large inroads into a disease that hadn’t seen much progress toward a treatment. With a particularly high price tag and no competition from other companies, the potential for investor profits was enormous. Because cystic fibrosis is classified as an “orphan” disease — affecting fewer than 200,000 people — drugs developed to treat the rare condition are given special privileges under the Orphan Drug Act: exclusive marketing rights for seven years, tax credits for clinical trials and government research grants.

So it was not surprising that markets might move dramatically for a Kalydeco-based drug to treat the majority of those with cystic fibrosis — which is what exactly happened in May 2012.

Partial results from a phase II clinical trial showed that combining Kalydeco with an experimental drug, lumacaftor (VX-809), appreciably improved lung function in patients with the most common mutation type of cystic fibrosis. Patients enrolled in the trial for the combination treatment — eventually named Orkambi — showed a 10 percent improvement. For a cystic fibrosis treatment, it was a phenomenal result.

Immediately after announcement of the news, Vertex’s stock jumped 55 percent in volatile trading. Over 40 million shares exchanged hands that day, in the company’s biggest trading day in the last five years.

Adam Feuerstein of investment news site TheStreet heralded the clinical trial results. In a post titled “Vertex is the next Gilead Sciences or Alexion,” he compared Vertex to two previous biotech startups that became billion-dollar behemoths.

But three weeks after the highly positive news, Vertex retracted its announcement. Subjects given Orkambi showed only relative improvement, not absolute improvement as previously reported. Rather than 28 out of 37 patients in the cohort showing a marked or decent improvement, the number was only 20. For a clinical trial with few subjects, that was a significant difference.

After the retraction, shares of the company’s stock immediately fell 10.8 percent in value. In a conference call, Vertex CEO Jeffrey Leiden apologized for the error and blamed an unspecified outside vendor for misinterpreting the data. “This is a nonacceptable error, and we are taking steps to fix it and make sure it doesn’t happen, and I just wanted to be clear on that,” he said.

‘This is a nonacceptable error, and we are taking steps to fix it and make sure it doesn’t happen, and I just wanted to be clear on that.’

Jeffrey Leiden

CEO, Vertex

During the short-lived spike, Vertex executives sold 539,313 shares worth over $31 million. Executive Vice President Nancy Wysenski netted $8.8 million in trading. Other executives and institutional investors reaped gains in the millions of dollars from their stock sales. Hedge funds, which invested over $14 billion in Vertex in the previous months, quickly sold the vast majority of their shares. While insiders made millions, pension funds that invested in the company after the spike took a hard hit when the stock fell.

Iowa Sen. Chuck Grassley demanded a probe of the trades. The head of the SEC, Mary Schapiro, said his request was being considered but never publicly announced an investigation.

The SEC, Grassley’s office and Vertex all declined to comment for this story.

Numerous civil lawsuits on behalf of pension funds have since been brought against Vertex for stock manipulation. A lawsuit by the pension fund for the city of Bristol, Connecticut, pointed out that, regardless of any insider trading by its executives, Vertex was guilty of disseminating false and misleading information with the 2012 press release — violating SEC regulations S-X and S-K — and alleged that Vertex insiders had the knowledge and access to prevent the mistakes from being announced.

A lawsuit by the International Brotherhood of Electrical Workers retirement plan accused the company of manipulating stock prices and doing so strategically to make up for lost revenue after hitting some trouble with other drugs. In particular, it was referring to Vertex’s struggle to find a treatment for hepatitis C.

For many years, Vertex dedicated itself to finding a drug to treat the disease, and the efforts were rewarded when the company discovered and received FDA approval for the drug Incivek. But in the competitive biotech market, there were already numerous other companies working on treatments. Vertex was quickly bested by a hepatitis C medication developed by Pharmasset called Sovaldi (sofosbuvir). With fewer medical complications than Incivek, Sovaldi quickly became the top-selling treatment.

Vertex’s development of an anti-inflammatory drug (VX-745) for treating rheumatoid arthritis was sidelined when reports of neurotoxicity during clinical trials effectively scrapped the project.

But before the toxicity reports on VX-745 were released to the public, Vertex executives sold shares. In this instance, the SEC brought up charges of “false and misleading statements” against executives for essentially buoying the stock’s price while they knew of the impending announcement of the drug’s failure.

Keeping the negative news out of the press not only benefited executives’ stock portfolios, it allowed Vertex to buy Aurora Biosciences, a small biotech firm in California founded by scientists at University of California at San Diego. Over the previous few years, Aurora made great strides in finding a treatment for cystic fibrosis. The research pioneered at Aurora would eventually lead to Vertex’s development of Kalydeco.

Vertex Pharmaceuticals headquarters in Boston. The company has become a symbol of not just the biotech market’s volatility but also lax regulation by the SEC.
Boston Globe / Getty Images

In the cases of Orkambi and VX-745, Vertex was accused in lawsuits of manipulating the results of clinical trials to sell shares. And in both cases Vertex executives pleaded ignorance. For VX-745, they insisted that they were unaware of the rheumatoid arthritis drug’s potential side effects at the time they sold their stock. For Orkambi, Vertex executives stated that they had no knowledge of the flaws in the cystic fibrosis treatment data. The trades were made based on stock price alone, not on any inside information, they said. Wysneski claimed she had already arranged to sell when the stock’s value hit a certain amount.

This last part of Wysneski’s defense — that her trades were planned in advance and not intentionally made at the time the data were released — is part of a long-standing loophole under SEC rule 10b5-1 that allows automated trading to fall outside insider trading statutes. It allows executives to carry out “preplanned transactions at a later time, even if they later become aware of material nonpublic information.” Planning of stock sales like this is done solely through a broker. There are no requirements for the trading plans to be registered with the SEC or, sometimes, disclosed at all.

Many see that loophole as egregious. University of Colorado accounting professor Alan Jagolinzer asserts that planned, or algorithmic, transactions can be used to bypass numerous SEC regulations. With planned trading, stock sales may be executed within blackout windows — when trading by insiders is otherwise barred.

It also allows insiders to selectively release information or cancel trades on the basis of inside information to the benefit of a stock sale. Executives privy to a drug’s poor performance can cancel a planned stock purchase right before releasing negative information to the public. Or they can plan a stock trade and time the release of company information accordingly.

According to Jagolinzer, 10b5-1 plans “generate abnormal trade returns,” and many such strategic trades “are associated with pending adverse news disclosure, and … participants terminate sales plans before positive shifts in firm returns.”

Planning trades through 10b5-1 plans doesn’t absolve a trader from insider trading allegations, but many of them offer plausible deniability. According to Jagolinzer, allegations become more difficult to prove “because the information held about future firm performance tends to be perceived as less certain” the farther the trade is executed from the date it is planned.

The Council of Institutional Investors — a corporate advocacy group representing numerous pension plans, endowments and foundations, with $3 trillion in investments — has repeatedly written to the SEC to amend the rule, asking for regulations on disclosure and restrictions on overlapping transactions. But the rules have not been changed.

Vertex’s Jeffrey Leiden receives one of the largest compensation packages among CEOs of public U.S. companies.
Boston Globe / Getty Images

According to documents provided to Al Jazeera, the SEC opened an investigation into Vertex Pharmaceuticals shortly after the Orkambi incident but then declined to follow through with prosecution. While the SEC requested documents from Vertex for the investigation, it looked into only the events and trades surrounding the retraction of the press release. There is no evidence the SEC investigated the flawed press release or the unspecified outside vendor behind it.

Why the SEC neglected to investigate the press release is unknown. Lynn Turner, previously a chief accountant with the SEC, wondered if the agency could be ignoring the case because the company’s stock has continued to climb ever since. Shareholders who held on to the stock didn’t lose enough to warrant civil proceedings from an agency strapped for resources. “If they held on to their stock, then they didn’t have much to complain about,” he added.

Robert Wilson, a former lawyer with the SEC’s enforcement division, noted that the agency has no written policy about selective prosecution and no too-big-to-fail or too-important-to-fail criterion for biotech companies. But he said cases can be ignored for a wide variety of reasons and added that “an investigation, by itself, is not typically going to cause a company to fail.”

The SEC could have neglected to prosecute the company because of lack of resources, rising stock prices and the difficulty of prosecuting over the wording of a press release, but there is no easy way to tell. The SEC’s enforcement division is often portrayed as an opaque and insular institution. It readily admits on its website that its investigations are “conducted confidentially to protect evidence and reputations” and that it does not usually respond to FOIA requests on open investigations, which it is legally allowed to do under exemption 7(a).

Companies can voluntarily announce that the SEC is investigating them, but few choose to do so.

“They’re not like cops,” says John Gavin, a financial analyst who runs ProbesReporter, a site dedicated to FOIA-based investment research. He insists that not only does the SEC refuse to comment on open investigations but it also often doesn’t release information on closed investigations. According to him, the SEC regularly ignores FOIA compliance by neglecting to release case closing recommendations and other reports that detail what took place during an investigation.

Stanford Graduate School of Business professor Ed deHaan, who has researched the influence of revolving door relationships on SEC enforcement, noted that “the SEC has a finite budget and staff, so they allocate those resources to the cases that will have the biggest impact and also that have the highest probability of success.” The agency must “walk a line between being too transparent about the companies it investigates, which could negatively affect inculpable firms’ stock prices, and too opaque, which leaves open the possibility for inaction.”

But what is not opaque is the large sums of money that some top Vertex executives have reaped. Institutional Shareholder Services, a corporate governance adviser, called Vertex CEO Jeffrey Leiden’s pay “excessive” and “not contingent upon rigorous performance conditions.” According to the Bloomberg pay index, he ranks 40th in pay for CEOs of publicly traded U.S. companies. While Vertex hasn’t been profitable since 2012, he was given $45.8 million in total compensation for 2014.

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