United States: Life Sciences Companies Face Special Disclosure Challenges

By Sergio Garcia*

Life sciences companies face difficult disclosure issues because they operate in a particularly complex and financially sensitive regulatory environment. Given the necessary time and financial commitments, new product development is mission critical to the life sciences company. Naturally, this also creates keen investor incentives to track closely the progress of products in a company’s pipeline through each stage of clinical development.

The time to market for a new biotechnology product may stretch as long as ten to fifteen years, and company spending for a single prescription drug from initial research through FDA approval ranges from $800 million to $1.7 billion. To fund their substantial development costs as they mature, many life sciences companies seek to tap the public capital markets through an initial public offering. The public markets appear receptive to these offerings; while the total amount raised in the capital markets declined from $4.98 billion in 2004 to $2.24 billion 2005, healthcare companies represented 21 of the 41 IPOs during 2005, raising over $1 billion of capital. VentureWire (January 3, 2006).

As more life sciences companies enter the public marketplace, they must be prepared to face the pressures of public investors for the first time. Specifically, the new publicly-traded life sciences company must address special disclosure issues arising from the fact that the long and uncertain path to new product approval makes information about clinical developments especially valuable to investors and sensitive to the company. The market value of a life sciences company can rise or fall rapidly on investor perceptions of the company’s ability to bring a product out of development and into the market. Managing news about the likelihood of a product’s success—or failure—can be a dramatic high wire act. Companies with multiple products in the pipeline may find the pace and the scope of press releases needed to meet the demand for news about the company to be particularly challenging.

While they represent only 2% of U.S. public companies, life sciences companies are defendants in a disproportionate share of shareholder class action litigation—17% in 2003 and 10% in 2004. PricewaterhouseCoopers’ "2004 Securities Litigation Study" as cited in "Rise in Biotech Lawsuits" San Francisco Chronicle (January 26, 2004). Shareholder litigation during 2005 is consistent with this trend, with biotechnology companies continuing to serve as targets for a disproportionate number of the lawsuits filed. Shareholder Class Action Study, Woodruff-Sawyer. Many allegations against life sciences companies focus on product life cycle issues, including alleged misrepresentations concerning product efficacy, safety and clinical trial results. Eighty-one percent of cases filed against biotechnology companies allege misrepresentations relating to the company’s products, and 45% contain allegations relating to clinical trial results. Woodruff-Sawyer: A Study of Shareholder Class Action Litigation (2002).

Three recent examples of shareholder class action litigation and securities regulatory enforcement activity following the release of negative news about the safety of a drug product or product manufacturing process serve as useful illustrations of the problems facing life sciences companies:

• On February 17, 2005, Biogen Idec notified the FDA that a patient in the clinical trials for its recently approved multiple sclerosis drug, Tysabri, had suffered a serious infection, PML, a form of multiple encephalopathy. Just a day before, Biogen’s executive vice president announced in a release that "Tysabri, with its significant effect on slowing the progression of disability, offers new hope for patients with MS." (www.elan.com/news (February 17, 2005). The company’s shareholders did not learn about the patient with PML until ten days later, when Biogen and its marketing partner, Elan Corp., announced that the sick patient had died and that the drug had been withdrawn from the market. Within a few hours, Biogen’s share price dropped by 43% and investor class actions soon followed. The SEC, too, launched an investigation into the content—and timing—of management’s public disclosures for Tysabri.

• In October 2004, regulators in the U.K. forced Chiron to shut down its vaccine production facility in Liverpool, effectively obliterating the U.S. flu vaccine supply for the winter flu season. Chiron’s shares dropped more than 16% within hours of the news reports on the shuttered facility. A securities class action soon followed, with investors claiming that the U.K regulators had long expressed concern about Chiron’s Liverpool facility and that management should have publicly disclosed these regulatory concerns and the potential risk that a serious disruption in the supply of flu vaccine was possible. Meanwhile, the SEC started its own investigation into what management knew about the regulatory problems in the U.K., and when.

• In September 2004, Merck withdrew its arthritis drug, Vioxx, from the market after findings that the drug potentially raises the risk of heart attacks and strokes. Securities class actions followed, with shareholders questioning when Merck became aware of the risk, and alleging that the company failed to provide regulators and the public sufficient information about the Vioxx risks. The SEC also began an investigation into Merck’s handling of the news surrounding the safety of Vioxx.

In addition to the serious risk of securities class action litigation, life sciences companies must face the reality that they have two major regulatory agencies monitoring their activities. In recent years, the FDA and SEC have continued to enhance their interagency cooperation in reviewing disclosures by life sciences companies. In February 2004, the SEC and the FDA announced a centralized procedure for FDA staff members to make referrals to the SEC if the FDA staff member believed a public disclosure by a FDAregulated company constituted a false or misleading statement. The FDA has also appointed liaison officers to enhance cooperation with the SEC and to streamline the FDA’s technical assistance to the SEC in its review of the public filings of life sciences companies.

A recent SEC investigation of Biopure illustrates how it and the FDA work together:

• In September 2005, the SEC filed a civil fraud suit against Biopure in which the agency alleges that the company made misleading statements about efforts to obtain FDA approval for its synthetic blood product, Hemopure. The SEC began its investigation of Biopure in late 2003, based on the concern that Biopure had not adequately disclosed communications with the FDA concerning Hemopure’s clinical trial progress. When the company disclosed the SEC’s investigation, its share price immediately dropped 14%.

• In press reports about the investigation, the SEC’s District Administrator acknowledged the role of FDA cooperation in launching the investigation by noting that the SEC’s investigation of Biopure "was initiated after [the SEC] received a communication from the FDA." Boston Globe (Oct. 10, 2005). He went on to say that the FDA’s cooperation "was very helpful to [the SEC] during the investigation." Boston Globe.

While the SEC is still driving enforcement actions, it is likely that the FDA’s cooperation will continue to become more prominent in these investigations. With the assistance of the FDA, public disclosures of life sciences companies will remain subject to closer scrutiny by the SEC.

Publicly-traded life sciences companies face all the disclosure issues that other public companies confront, and much more. What can they do to reduce the risk of securities litigation and SEC investigation? Here are steps that could significantly reduce the risk:

• Review the design and effectiveness of your disclosure controls

While each organization has its own unique culture and decision-making processes, it is incumbent on every life sciences company to design its internal disclosure controls to ensure that appropriate company personnel learn—in a timely manner—about information that might involve a mandatory disclosure under SEC or stock exchange rules, or that is otherwise material and could have an impact on the market price of the company’s securities if disclosed.

Each company must analyze all the elements of its disclosure system. Key areas include financial reporting, investor communications and legal compliance. Managers in key operational areas, such as clinical development and manufacturing, should be aware of how issues within their areas of responsibility can play a role in increasing the risk of securities litigation.

Companies should be aware that disclosure controls should extend to all public communications because investors watch all disclosures for clues about the company. Obviously, covered material would include financial statements, earnings releases, other press releases, prospectuses, annual reports and Forms 8-K. For life sciences companies, disclosure controls should also cover presentations at scientific conferences, publications, and information presented to analysts and credit rating agencies. Information posted on the company website should be reviewed on a regular basis. Any material information posted on the company’s website should first be disseminated in a regulatory filing or press release. Any hyperlinks to third party sites should be accompanied by a clear and prominent disclaimer of such third party information to avoid confusion about the source of the information.

Disclosure controls and procedures are effective only if they provide the company reasonable assurance that information that is material to the company is being identified, gathered and communicated to the appropriate senior managers, including the CEO and CFO, on a timely basis. It is only with an effective system of disclosure controls that CEOs and CFOs can be prepared to certify that all of their company’s public filings are complete, accurate, consistent and timely.

• Review your disclosure control policies and procedures

Reviewing the company’s documented policies is an important part of the evaluation process.

Companies are well advised to have, and regularly to review, a communications policy that is consistent with the company’s culture and with the existing practices for the communication of company information.

The policy review should consider whether the communications policy, at a minimum, accomplishes the following objectives:

• Does the policy designate authorized spokespersons for the company—for financial information, clinical results and any other areas investors frequently ask about?

• Does the policy specifically identify the subjects for which each spokesperson is authorized to speak?

• Does the policy explicitly prohibit the selective disclosure of material nonpublic information about the company, which disclosure would violate Regulation FD (a securities regulation prohibiting selective disclosure of nonpublic material information)?

• Does the policy address the disclosure of information or data for products in development?

• Is the policy broadly disseminated such that all employees understand how news flow about the company should be treated?

A communications policy should also state company policy regarding chat rooms or message boards and about commenting on rumors about the company. First, as a general rule, companies should not sponsor, link or participate in chat rooms or message boards. The corporate communications policy may explicitly prohibit employees from discussing company matters in chat rooms, message boards and the like. By doing so, the company makes clear that such communications about the company are not authorized, the company does not undertake to review these communications, and the company disclaims responsibility for the content of messages posted by others. Second, the company’s policy may take a position on rumors—specifically, that the company will not respond to rumors about the company’s business. This is important to avoid serious securities law issues that often arise when a company feels compelled to respond to rumors or negative postings, including the risk of selective disclosure and the risk that the company may create an expectation that it will continue to monitor and correct third party statements.

Companies are advised to have an insider trading policy applicable to all transactions in the company’s securities by officers, directors, and all other employees or consultants who have access to material nonpublic information. As part of a good compliance program, insider trading policies and procedures should be approved, and regularly reviewed, by counsel.

Management disclosure committees play a critical role in monitoring a company’s disclosure controls and procedures. Every public company should have one. Once the committee is formed, the committee’s composition should be reviewed regularly to insure that it includes appropriate members of senior management. For life sciences companies, this means the disclosure committee should generally include the CFO or controller, the chief medical officer, and representatives from marketing, medical affairs and investor relations. The company’s legal counsel generally serves as the chair of the committee and provides guidance, among other things, on the company’s determination of what information is material and when and how it should be disseminated.

The disclosure committee should keep good records of its disclosure control functions. The completeness, accuracy and consistency of its approach to assessing information that may be material to the company and its investors may be questioned from time to time. The committee reports on disclosure issues to the CEO, the CFO and, when appropriate, to the company’s audit committee. The CEO and CFO are required to certify quarterly disclosure about the effectiveness of the company’s disclosure controls, and have personal liability for those disclosures. The audit committee also should be aware of the process by which management arrives at its conclusion on the effectiveness of disclosure controls since the audit committee, in its oversight role, is required to review the company’s quarterly earnings releases and the board is required to approve the company’s annual report and the inclusion of the financial statements in the report.

• Pay Particular Attention to Disclosures in the Following High Risk Areas:

There are many stages in the clinical development process where a life sciences company can get into trouble in its disclosures. First, it is important to note that the FDA does not require a company to disclose the status of clinical trials. Indeed, the FDA, by statute, will not publicly disclose the existence of an investigational new drug application (IND) unless the application previously has been disclosed. 21 C.F.R. 312.130. After the initial filing of the IND application, companies sponsoring clinical trials and the FDA interact throughout the development path on such things as preclinical data, safety and efficacy data, CMC data, complete response letters, approvable letters, not approvable letters and clinical holds.

Similarly, there is no requirement under the federal securities laws to disclose clinical results to the public. Nevertheless, investors demand that companies provide updates on the progress of their products in development. Any news about a company’s clinical trials is capable of moving a company’s stock. The problem—and the risk—often lies in the tendency to present data in the most favorable light. Companies need to be careful about using words like "significant," "dramatic" and the like in presenting clinical data. There may be times when this is justified; however, it is better practice to allow investors to draw their own conclusions about the company’s clinical results.

Clinical trial results must be communicated to the disclosure committee. In addition, the disclosure policy should provide for a clear process for counsel and regulatory personnel to be notified when clinical results are imminent. Prior counsel and regulatory review is essential so that appropriate and balanced disclosure of the data can be prepared, and so that any releases, securities filings and public statements contain appropriate forward-looking statement cautionary language or risk factors that are specific and meaningful.

The recent SEC investigations of Biopure and Chiron underscore the need for life sciences companies to redouble their efforts to monitor disclosures relating to discussions with regulatory authorities.

While it is not necessary or appropriate to publicize every communication with regulatory authorities, if the company determines that information received from the FDA is material, it should consider disclosing that information. Be aware, however, that any statements of fact regarding discussions with regulatory authorities can be used by securities class action lawyers or the SEC as the basis for a lawsuit or an investigation. Companies should ensure that their filings and public statements contain cautionary language that is specific and meaningful. Making sure that the regulatory team responsible for communications with the FDA has reviewed and approved any such public statement is also part of a good disclosure process.

The take-home message here is clear: the SEC is increasingly active in monitoring public disclosures by life sciences companies, and the FDA is in a position to assist the SEC in initiating investigations of life sciences companies’ public disclosures. The tremendous disclosure pressures life sciences companies face make it particularly important for them to manage and monitor their public disclosures to minimize risk of regulatory action or litigation. Hurried disclosures – or disclosures that are not carefully reviewed by counsel and regulatory personnel before release – create at best a major annoyance for senior management, and at worst serious credibility problems and litigation for the company.

*Sergio Garcia is the Co-Chair of the Life Sciences Group and a Partner in the Corporate and Intellectual Property Group, at Fenwick & West LLP.

An abbreviated version of this article has also appeared in the March 1, 2006 issue of the Dow Jones Corporate Governance newsletter.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.