Summary
- Hedge funds managers are attacking what they see as “weak patents” held by pharmaceutical companies while they are also shorting the stock at the same time.
- The hedge fund managers patent challenges are controversial because the pharmaceutical industry contends that such managers are exploiting a process designed to aid patent holders in defending themselves.
- The process used by hedge fund managers is known as Inter Partes Review, which allows petitions to strike down patents to be heard by a patent office panel.
- The process was created to assist companies to fight against patent trolls with a less expensive more efficient process than a more expensive patent litigation.
- Investors should be aware of this new hedge fund tactic, especially investors in pharmaceutical companies that rely on one or two products for most of their sales.
Just when you think hedge fund funds have run out of ways of making boatloads of money for themselves and their investors, they come up with a new way to make money. In a tactic that would seem like a conflict of interest to us, hedge funds are attacking what they see as “weak patents” held by pharmaceutical companies while they are also shorting the stock at the same time. In particular, a hedge fund will short the stock of a smaller pharmaceutical company that relies on one or two patented drugs for the majority of its sales and also challenge the patents that protect such drugs.
To us, this new tactic by hedge funds does not differ very much from hedge fund billionaire Bill Ackman’s tactic of shorting Herbalife (NYSE:HLF) and then pushing the U.S. Federal Government to investigate HLF for its business practices. Effectively then you have a hedge fund shorting while they create the news that potentially will cause the shares they are shorting to drop in price. Somehow, to us it seems quite unethical for an investor to be able to short a stock and take actions themselves simultaneously to cause the stock to drop rather than the company’s failed performance being the reason for the stock dropping. In fact, the U.S. Department of Justice or the F.B.I. has been said to be investigating Mr. Ackman for his tactic regarding his HLF short position.
In particular, federal investigators contacted a consulting firm Mr. Ackman hired for his campaign against nutritional supplements company HLF as the government probes potential manipulation of the firm’s stock. Perhaps there should be a law against this kind of tactic? We think there should be some kind of regulation preventing this type of tactic from taking place. This article, however, is not really about the morality of such a tactic, but rather bringing it to our readers’ attention. As stated above, the new hedge fund tactic is shorting the stock of a drug company while attacking one or more of its patents at the same time.
According to multiple news stories, hedge-fund manager Kyle Bass, recently began filing and publicizing patent challenges against drug companies while also shorting their shares. One such company is Jazz Pharmaceuticals (NASDAQ:JAZZ) and the patents that protect its narcolepsy drug Xyrem. Xyrem had sales of $779 million in 2014, two-thirds of Jazz’s 2014 revenues. (subscription required for link) Prior to Mr. Bass’ patent challenge against JAZZ, he filed patent challenges against patents owned by Shire plc (NASDAQ:SHPG) for a drug for ulcerative colitis and a drug for treatment for short bowel syndrome. He also challenged a patent owned by Acorda Therapeutics (NASDAQ:ACOR) for multiple sclerosis.
Mr. Bass, emphasizing his altruism to help society, according to the Wall Street Journal stated that he targets weak patents that keep drug prices high. (subscription required for link) The pharmaceutical industry, also according to the Wall Street Journal, countered such an altruistic statement by stating, “There’s nothing in this man’s history to suggest he has any interest in lowering health-care costs.” (subscription required for links) Mr. Bass’ challenge to what he considers weak patents held by pharmaceutical companies uses a relatively new and inexpensive petition process to invalidate patents. Mr. Bass created the Coalition for Affordable Drugs, an organization that is the lead petitioner in several patent challenges filed with the U.S. Patent and Trademark Office. (subscription required for link) Mr. Bass, again emphasizing the altruism in his actions, also according to the Wall Street Journal, reiterated that his patent challenges will reduce drug prices that he believes are kept artificially high due to patent protection. (subscription required for link)
In the U.S., patented drugs generally receive a 20-year period of market exclusivity from the date of patent filing before generics can be sold at steep discounts. We should note, having practiced in the area of patent law ourselves, that a portion of such a 20-year period is taken up by 3 phases of U.S. FDA testing and drug trials and that if and when a patented drug is approved for sale much less than a 20-year period of patent protection is left to protect such drug once it is available for sale.
The actions by Mr. Bass are controversial not only for the ethical reason we identified above, but also because the pharmaceutical industry contends, as reported in the Wall Street Journal, that hedge fund managers are “exploiting a process designed to aid patent holders in defending themselves, twisting it to provoke fear among his target’s investors, and then gain from the fallout that may result.” (Subscription required for link) The process used by hedge fund managers such as Mr. Bass is an administrative process known as Inter Partes Review, or IPR, that allows petitions to strike down patents to be heard by a patent office panel. The process was created by the U.S. Congress in 2011 to assist patent owning companies to fight “patent trolls,” nonoperating companies that extract cash settlements from companies they accuse of patent infringement.
The panel is a cheaper and faster option than trials in federal courts, thereby reducing the high costs for patent holders defending themselves against patent trolls in the traditional patent litigation process in a U.S. District Court and on appeal at the U.S. Court of Appeals of the Federal Circuit. A challenge under the IPR process involves the evaluation of patents at issue by a panel of three administrative patent judges who use a broader set of criteria than the courts when deciding whether patents should be invalidated, making it much easier to strike down patents, experts indicate. According to a recent study, about 77 percent of patents evaluated through the IPR process have been invalidated or disclaimed by their owners. Pharmaceutical executives critical of the use of the IPR process to challenge pharmaceutical patents, according to the Wall Street Journal, state that the petition process was never intended to be used in the manner hedge fund managers are using it. As of the writing of this article, the U.S. patent and trademark office has not indicated whether it will review the Coalition for Affordable Drugs’ petitions.
Conclusion
The new IPR process is a potential game changer for pharmaceutical companies who protect their innovations with one or more patents. Now, prior to the creation of the IPR process, generic drug companies were able to challenge patents held by innovative pharmaceutical companies through theAbbreviated New Drug Application (“ANDA”) process, which typically involves a long drawn out very expensive litigation process that ends only upon a Court of Appeals decision or a settlement between the parties. The IPR process, however, reduces the time and cost to challenge one or more patents, thereby opening the door for hedge fund managers to use the IPR process in a manner not contemplated by the legislators that created it or by the companies that own a substantial number of patents that lobbied for such a process.
Now, of course, invalidating one or more patents is not as easy as it seems. From our experience working at an intellectual property law firm, we should note that pharmaceutical companies usually do not protect their key drug products with just one patent, but frequently apply for and receive multiple patents to surround the central innovation that becomes a marketed drug product. For example, a pharmaceutical company may apply for patents for the drug compound itself, the one or more methods of manufacturing such compound and the method of administering or using such compound in a treatment regimen. With multiple patents, a pharmaceutical company can withstand the invalidation of one patent relating to a particular product and still be able to protect its product if the additional patents related to the patented drug are held valid.
Currently, no one knows how effectively hedge fund manager challenges to pharmaceutical drug company patents will be. Regardless as to the certainty of such patent challenges, there are reports that there is nervousness in the pharmaceutical industry about the new cost-effective IPR process being used against their critical patent protection for its products. There is one other certainty, however, and that is that pharmaceutical companies recording hundreds of millions or billions of dollars in yearly sales for their products will spend as much money as possible in defending their intellectual property. Potential investors in pharmaceutical or biopharmaceutical industries should take note of this latest development in the pharmaceutical industry. In particular, potential investors in companies relying on one or two patent protected drug products for the vast majority of their sales should be especially careful.
