Psst! Hey Doc...Got a Hot Stock Tip?

As 2005 draws to a close with the various biotechnology and pharma stock indexes inching upward (the Morgan Stanley Biotech Index was up 3.44% in October), the prospects for a brighter and more profitable 2006 seem fairly positive. If 2004 was any indicator when the Biotech Index climbed 12% in November and December after moderate growth in October, then Christmas could come early for bioscience investors.

Brian O'Connell

In the January issue, I'll write more about what to expect in 2006, and what lessons the life sciences industry can learn from the events of 2005.

This month, though, a scandal is brewing in biopharm circles that could blow the top off the industry and make it much more difficult for doctors and biopharm research companies to share critical research information — and possibly put some physicians behind bars who try to put a price tag on the sensitive research information they hear about from biopharm industry companies.

HERE'S THE SKINNY:

According to a thunderbolt special series from The Seattle Times, prosecutors are preparing charges against medical researchers who allegedly sell confidential information from prescription drug studies and release that information to Wall Street analysts.

It's a growing market, if not a pretty one. Big-time investors often pay up to $1 million for such information. Doctors can charge up to $500 per hour to discuss the pros and cons of clinical drug trials. One firm, Gerson Lehrman Group (www.glgroup.com), even acts as a matchmaker, lining up analysts to talk to any one of 60,000 doctors ensconced in the firm's database. In 2002, that number was 30,000.

Let's visit planet Earth for a moment. I spent five years as a bond trader in New York and one fact of life I learned was that when an analyst got a hot tip, it was only a matter of seconds for that tip to be passed along to favored clients.

And that practice is illegal. You can't take insider information relating to any company's financial prospects and pass it along to investors. Such actions create an uneven playing field and reduce investor confidence in the integrity of the financial markets.

Worse still, the doctors involved in the alleged gambit charged analysts hundreds of dollars per conversation — beer money on Wall Street — for access to potentially hugely profitable information they had in hand.

The Times expose, researched and written by reporters Luke Timmerman and David Heath, found at least 26 cases of insider trading related to drug research between doctors and stock analysts. The doctors involved weren't pikers either. Blue-chip research universities such as UCLA and The University of Pennsylvania (full disclosure: I taught, and was compensated for, a writing class at Penn earlier this autumn) were involved, as were old, established financial firms like Citigroup and Wachovia Securities.

DOCTORS: WHAT'S ALL THE FUSS?

In most instances, doctors allegedly involved in the insider trading scam delivered proprietary information about confidential studies they were working on to Wall Street analysts. The Times alleges that the analysts subsequently passed the information along to clients.

The Times states that "until now, the selling of drug secrets has been hidden from securities regulators and the public, but biotech and Wall Street insiders say the practice is widespread." The practice is being driven by hedge funds — largely unregulated investment pools that cater to the super rich — and is facilitated by firms like Gerson Lehrman. Matchmakers pay the scientists $300 to $500 per hour to speak with the investors. According to legal experts interviewed by the newspaper, "trading stock based on secret information bought from medical researchers is illegal." A 1983 US Supreme Court decision found that analysts are free to gather information about companies and pass it on to their clients, but added that analysts are forbidden to persuade someone to divulge company secrets, claiming that practice is "misappropriating" nonpublic information.

The Times also reports that doctors involved in the case were annoyed that investigators would find anything inappropriate about their passing along proprietary information to Wall Street analysts. Some physicians quoted in the series claim the information they discussed with analysts was already in the public domain and that it wasn't very useful. One doctor cited in the piece, Corey Langer from the Philadelphia-based Fox Chase Cancer Center, told reporters that he was only giving out personal opinions on ongoing studies and research, and what he said was clearly within the limits of the SEC's (Securities and Exchange Commission's strict rules on confidentiality.

CLEAR CONFLICT

We'll let the SEC and congressional investigators sort this mess out, but the burgeoning trend of doctors being paid money by Wall Street investment firms is deeply disturbing and ought to be abolished. According to the Journal of the American Medical Association (JAMA), the number of doctors who accept money from Wall Street firms has risen from fewer than 1,000 in 1995 to roughly 75,000 today.

What's the big deal? Besides the obvious conflict of interest in a private investment firm "buying" time and information from doctors and researchers deeply involved in sensitive drug research, there's a big ripple effect in how such fee arrangements negatively impact clinical trials. As The Times series attests, a "worst case" scenario might involve a physician inflating up clinical data to ensure that the analyst was getting his or her money's worth for the fat fees paid out to researchers. Conversely, a doctor who hears from an analyst that results from a given drug trial would help the drug company's stock may tend to select healthier study participants to "push" the drug toward better study results — then cash in on the stock frenzy that usually follows. As Drummond Rennie, deputy editor at JAMA told The Times, "When the data leaks out, it wrecks the trial."

With so much at stake, it's no surprise that Congress is itching to get involved. Senator Charles Grassley from Iowa is making the most noise, urging both the SEC and the department of Justice to conduct investigations into a potentially block-buster-sized drug trial payola scandal. Said Grassley in a letter to the House of Representatives, "We need a complete and thorough review of these findings and allegations. Selling drug secrets violates a trust that is fundamental to the integrity of both scientific research and our financial markets."

What are the chances of some doctors doing a perp walk on CNN? (Led away in handcuffs on TV.) I'd say 50-50. As a separate article in The New York Times points out, federal investigators have their work cut out for them. The SEC would be the primary investigators and they have jailed a few over the years on insider trading charges (including a handful in the biosciences sector). You may recall former executive Eric Tsao of biotechnology company Med-Immune Inc., who was sentenced to 15 months in prison for insider trading and perjury, as reported by the Department of Justice a few years ago. There have been others. But those were clear-cut cases of biotech executives leaking company financial information directly to Wall Street types.

The doctor-analyst tango is more nuanced and tougher to prove. As The New York Times reports, SEC investigators must "weed through a number of complex issues determining whether securities laws have been breached," and their job will be "challenging." The key for regulators is to prove that the information changing hands is valuable enough to convince a trader to buy or sell the company-in-question's stock. Says The NY Times, regulators must also demonstrate that the information in question was "non-public" and that medical researchers did, in fact, breach their confidentiality agreements (agreements often can vary in scope and discipline).

What concerns me is the casual indifference on the part of doctors whose judgment patients must come to trust. It's a credibility and trust issue and doctors must always pass those types of tests. But what do we get? Quotes like the one Ben McGraw, an ex-Wall Street analyst at the California-based biotech firm Valentis, told The Seattle Times "Everybody does this.... It's now common practice."

Okay, so the practice of doctors talking to analysts is more pervasive these days. But that doesn't make it right. Any time money changes hands between doctors and slick Wall Street market mavens, any investor's antennae ought to go up (not to mention the patients who may one day use the drug in question).

Now it's time for this practice to fail its clinical trial.

Celebrity author and business/finance commentator for CNN and Fox News, Brian O'Connell has written for The Wall Street Journal and Newsweek,79 Radcliffe Drive,Doylestown,PA 18901,267.880.3144, fax 267.880.1939, brian.oco@verizon.net