FDA Insider Trading: Time for an Overhaul?

by: Kinetic Investments

On March 29, 2011, the US Securities and Exchange Commission [SEC] announced that it had charged a US Food and Drug Administration [FDA] chemist and his son ("the accused") with insider trading ahead of FDA decision announcements.

At least 27 separate trades on at least 19 different NASDAQ listed securities spread across at least seven different trading accounts have been tied to the chemist, who allegedly took liberties with his FDA security clearance by accessing confidential databases for the purposes of reviewing and acting on sensitive material information before such information could be released to the general public.

The accused allegedly made $216K trading Momenta Pharmaceuticals (NASDAQ:MNTA), $469K trading Progenics Pharmaceuticals (NASDAQ:PGNX), and most notably, $1.1M while trading Vanda Pharmaceuticals (NASDAQ:VNDA). In all, they are told to have pulled in a tidy $2.27M. It is also alleged that much of their ill-gotten gains were used to purchase automobiles and pay credit card bills.

This news has caused a justifiable uproar among the biotech investing community, as the recently filed charges have only added to many investors’ already existing concerns about insiders taking advantage of the FDA's application review process.

What I have found to be most disheartening about this story is that the accused appears to have narrowly avoided taking a $174,409 loss by selling Pozen Pharmaceuticals (NASDAQ:POZN) shares on August 1, 2007, just one day before the company announced it had received a second “approvable letter” (now known as a "CRL") from the FDA for its migraine product, Trexima.

While the accused apparently escaped the above referenced debacle unscathed, many investors watched in disbelief on August 2, 2007, when Pozen’s stock lost more than 43% of its value. In a similar situation earlier this year, the accused skirted a $60K loss by selling a MannKind Corporation (NASDAQ:MNKD) stake before the FDA officially issued a CRL for the company's diabetes product, Afrezza.

What's odd about the Pozen and MannKind transactions and what separates them from the rest is that the evidence seems to indicate that the accused either initially bought POZN and MNKD expecting the FDA to rule in favor of Trexima and Afrezza only to catch their mistakes in enough time to sell their shares and avoid substantial losses, or they initially bought the shares hoping to profit from PDUFA date “run-up” plays and never intended to hold the shares through the decision dates.

I have difficulty believing the latter explanation, as the accused simply do not strike me as speculators or bio run-up players; accordingly, I must now wonder if the FDA had changed its opinion(s) during the review periods for the two drug applications in question. I think I'll save that discussion for another time...

Time for an FDA Overhaul?

Possibly. The accused, in this case, seem to have started accumulating shares of many of the companies more than a week ahead of the actual FDA decision announcements, which causes me to wonder just how long the FDA is sitting on its decisions before handing them down?

In my opinion, this entire situation necessitates a careful review of the FDA’s protocols concerning when and how its decisions are released after they have been made as well as a thorough review of who has access to its notes and opinions concerning any product applications that are currently still under review.

Like many investors out there, I am wondering if the recent action taken by the SEC will be the first of many concerning insider trading as it pertains to the FDA and publicly traded biotech companies or if this situation will be dismissed as an "anomaly" with no need for follow through or regulatory change. Regardless of the outcome, I look forward to watching this case unfold and hope that any other wrong doers out there are feeling a bit uneasy after reading the recently filed complaint.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.