Could A Hedge Fund Manager Trying To Short Stocks Of Pharma Companies With Bad Patents Derail Patent Reform?

from the that-would-suck dept

Fri, Aug 14th 2015 11:30am — Mike Masnick

A few months ago, we wrote that it looked like much needed patent reform had stalled out in Congress, despite expectations that it would fly through Congress easily this year, having the strong support of both the majority party in Congress and the President. And this year, unlike last year, the trial lawyer lobby wouldn't be able to intervene. Of course, the one big obstacle -- as with every time patent reform is proposed -- would be the pharmaceutical industry. But even that seemed like it shouldn't be a huge problem because nearly all of the (relatively mild and fairly weak) reforms proposed really targeted trollish behavior, using overly broad patents to shake down innovative companies. Whether or not you approve of the way drug companies use patents, the trolling issue is a bit outside of that industry's concern, and thus it was believed that while pharmaceutical companies might whine a little bit, they wouldn't really stand in the way.

Except... something changed. As Julie Samuels explains in a blog post detailing the state of patent reform as it stands today, a Wall Street hedge fund guy got the pharma industry all riled up, by making use of a provision in the previous patent reform law to play some silly Wall Street game:

Enter Kyle Bass. The well-known hedge fund manager’s most recent enterprise involves using the IPR process to challenge weak pharmaceutical patents and then short the stock of the company that owns the patent. The pharmaceutical industry, which relies heavily on patent rights, is far from pleased. And despite the fact that the IPR process contains significant protections for patent holders and the fact that Mr. Bass’ actions can already be addressed by the SEC, the pharmaceutical industry has been able to shoehorn its issue into the larger reform efforts.

Let's unpack that a little. The "IPR" process stands for "inter partes review" and it's a process by which anyone can try to challenge a bad patent, by presenting specific evidence that it shouldn't have been granted because of prior art. This process is somewhat useful in helping to get the Patent Office to toss out some bad patent claims that it never should have approved in the first place. It's a fairly limited process too. You can file for an IPR, but the Patent Trial and Appeal Board (PTAB) will only take up the effort if it decides "there is a reasonable likelihood" that it will invalidate the claims based on the submitted material. In other words, it's a pretty high bar to cross, and anyone filing frivolous IPR claims won't get very far at all.

Now, back to Kyle Bass. He's been making news in the last few months by filing for an IPR against pharma patents, while simultaneously shorting the stock of the pharmaceutical firms that hold the patents. He's set up an entire organization to do this, called the Coalition for Affordable Drugs.

Kyle Bass, head of Hayman Capital Management LP—which made a fortune wagering on the housing bust—is targeting patents that he says have little value other than to drive up prescription drug prices. His new fund bets against companies whose patents it believes are spurious, and invests in those that would profit if the patents are invalidated, said people familiar with the matter.

His latest challenge seeks to employ a relatively new and inexpensive petition process to invalidate a Jazz Pharmaceuticals PLC patent for Xyrem, a narcolepsy drug with sales of $779 million last year, two-thirds of Jazz’s 2014 revenues.

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. He says he plans to pursue the cases regardless of share price moves. “We will not settle,” he said in an interview.

The Coalition has been busy of late, filing a whole bunch of IPR petitions against a whole bunch of phamaceutical firms. And, boy, are those pharma firms pissed off. Celgene, for one, has talked about seeking sanctions against Bass, claiming that Bass is using the process as a form of extortion:

Celgene attorneys made this point in a June 3 email to the patent office. But there was more. They also alleged that his coalition threatened to challenge Celgene patents “unless Celgene met their demands.” Those demands weren’t specified, but the email states that “when Celgene did not pay,” the patent challenges were filed, according to the patent office order, which cited the email.

And, using this whole story, to argue that the whole IPR process is a disaster, the pharmaceutical industry is trying to revamp and effectively destroy the entire (important and useful) IPR process.

And while it seems likely that Bass's efforts are much more about enriching himself via the stock shorting than actually making drugs more affordable, arguing that his efforts somehow undermine the entire IPR process is a stretch. Indeed, as noted earlier, there are built-in protections that make it rather inefficient for anyone to really abuse the process the way pharma companies are portraying. Again, the special board in the Patent Office, the PTAB, has the ability to just outright reject any IPR petition it doesn't think has a chance of surviving. And, in fact, a recent report by the Patent Office shows that (1) less than half of all IPR requests result in actual challenges and (2) even then, the vast majority of claims being challenged are actually allowed to stand. As of the end of June of this year, you can see that the PTAB rejects most petitions, many more are "terminated," and of those that go to a full trial, many retain patentable claims that were challenged:

Even more to the point, if you look at the total number of claims actually challenged, against those that end up being found unpatentable, it's a fairly tiny number: only 4,225 claims out of were challenged. That's less than 12%. Hell, even if you look at just those claims that the PTAB initiates proceedings on, less than 25% of them are invalidated.

In short, the idea that the IPR process is making it easy to simply kill off good patents is not even remotely supportable. Instead, it appears to be doing what it's intended to do: make it more reasonable to help people kill off bad patent claims. If pharma firms are worried about what Bass is doing, it should only be if the patents they have are questionable in the first place. If they're legit, they won't pass the laugh test, and the whole process won't get anywhere.

And yet... because the pharma industry just doesn't like having to deal with Bass at all, it's trying to destroy the whole IPR process, saying that's the only way that it will support the other aspects of patent reform. But undermining IPR would do serious damage to patent reform as a whole, and take away a key tool that actually does work in more quickly invalidating crappy patents. Whether or not you approve of the way in which Bass is doing what he's doing, the process isn't really open to abuse in a manner that should raise any real concern. And, for everyone else, the IPR process remains an important element in stopping abusive patents.

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Filed Under: inter partes review, ipr, kyle bass, patent reform, patents, pharma, pharmaceutical industry, ptab, short selling, uspto
Companies: coalition for affordable drugs, hayman capital management

31 Comments

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Anonymous Coward, 14 Aug 2015 @ 12:01pm

I was sure Kyle Bass was half of Tenacious D, but I guess I'm off by one letter.
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JoeCool (profile), 14 Aug 2015 @ 12:37pm

Why is shorting stocks still legal? Seems to me that should be a straight to prison for 5 to 10 years offense. It's really nothing short of fraud - you're selling something you don't have. In any other business than finance, you'd be in prison before you could blink.

It often seems like more than half of the practices financial institutions rely on to make money would be illegal in any other setting.
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Sheogorath (profile), 14 Aug 2015 @ 12:44pm

Big pharma: "You know, guys, this Kyle Bass is a big problem, so here's how we deal with him. Instead of getting the scumbag investigated for potential insider trading, we'll attempt to destroy one of the few useful things left in modern patent law. That'll show 'em."
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Anonymous Coward, 14 Aug 2015 @ 12:45pm

Mr. Bass' methods might be detestable but that's not as detestable as some of pharma's practices. Whatever it takes to get the pharmaceutical industry to realize their prices are EXTORTIONATELY high I'll support, even if that support is reluctant.
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OldMugwump (profile), 14 Aug 2015 @ 12:45pm

It's not fraud
It's not fraud.

Short sellers *borrow* stock from people who actually own it, and then sell it.

People with margin accounts sign a contract agreeing to let their stocks be borrowed this way.

It's all consensual and open.
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Wyrm (profile), 14 Aug 2015 @ 12:46pm

And yet... because the pharma industry just doesn't like having to deal with Bass at all, it's trying to destroy the whole IPR process

Sounds more like they're using him as a convenient excuse to ask for the ban of IPR.

"Look, there is this one guy that abuses the system, so we should bring the whole system down."

Funny enough, that "logic" could apply to the whole patent system if we were willing to play their game. There are quite a number of people abusing the patent system, so maybe we should bring the whole patent system down? (With the difference that we can show that the patent system is way more prone to abuse that the IPR.)
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Digitari, 14 Aug 2015 @ 12:50pm

wow
I used to work at a pharmaceutical company. The "cost" of manufacturing tablets (pills) was 1000 per PENNY (1 cent) the
"markup" was R&D (two guys in the lab that basically played around).
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saulgoode (profile), 14 Aug 2015 @ 12:53pm

Re:
Could you explain what you might find detestable about Mr Bass' methods?
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Anonymous Coward, 14 Aug 2015 @ 12:54pm

Re: It's not fraud
"People with margin accounts sign a contract agreeing to let their stocks be borrowed this way."

Not only that, but some brokers will pay long stock holders to lend their shares if they are in demand. The 'rental income' is treated as ordinary income, not capital gains. Buffet's firms make money from lending stock.
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Sheogorath (profile), 14 Aug 2015 @ 1:13pm

Re: Re:
If the guy's purchasing the stock he's shortingw that's insider trading. The detestability of that act is subjective, agreed, but it's still illegal wherever it occurs.
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Edward Teach, 14 Aug 2015 @ 1:33pm

Re: It's not fraud
Aye, laddie, how 'bout them "naked" shorts? Does any stock owner lend their stock to cover those shorts?

Saints preserve us, I sound like a bleedin pornographer, talking about "covering" and "naked" and "shorts".
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JoeCool (profile), 14 Aug 2015 @ 2:34pm

Re: It's not fraud
It may be consensual, but I doubt it's open. I imagine most firms bury the fact that they'll use your stocks to cover shorting way down in the fine print. And as long as they don't lose (too much) money, they won't really care. That actually makes the practice WORSE since you're consensually supporting fraud. It makes the others involved COMPLICIT, it doesn't make the shorter right.
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Mike Masnick (profile), 14 Aug 2015 @ 3:06pm

Re: Re: Re:
If the guy's purchasing the stock he's shortingw that's insider trading.

How is it insider trading? He has no insider information.
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JS, 14 Aug 2015 @ 4:51pm

Re: Re: Re:
Having both long and short positions in the same stock is absolutely legal. It's a well-known strategy for generating income from stock you own.
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Anonymous Coward, 14 Aug 2015 @ 5:48pm

Thank you Mr Bass , keep hitting them in their pockets.
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JoeCool (profile), 14 Aug 2015 @ 5:59pm

Re: Re: Re: Re:
It may be legal, but it shouldn't be. Things like this is why financial services led the way in the last recession. Gaming the system is a good way to crash the system, and crash it they did. Unfortunately, they don't wind up paying the bill, innocent people/taxpayers do.
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Tom Mink (profile), 14 Aug 2015 @ 7:14pm

Somebody needs to troll pharma
How can there not be a pile of overly general patents out there that instead of taking a well-known practice and adding "with a computer" it says "using a pill." Of course that ignores the huge number of new drugs that mimic existing drugs with little or no improvement in efficacy and only a slight change in mechanism. Pharma probably doesn't want the concept of prior art anywhere near their business.
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Anonymous Coward, 14 Aug 2015 @ 10:17pm

Re: Re: It's not fraud
I don't think you know how finance works.
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Anonymous Coward, 14 Aug 2015 @ 10:25pm

Re:
Insider trading... you mean like congress?
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Anonymous Coward, 14 Aug 2015 @ 10:30pm

Re: Re: Re: Re:
If the guy is purchasing the stock that he is shorting then it makes no sense... just like Sheogorath's comment.

He is shorting companies that are overvalued and letting y'all know they are overvalued by exposing a weak patent (that probably should not exist) that is supposed to be the value of the firm. Kind of like muddy waters exposing Chinese shell company frauds. This is an essential role in capitalism... just not fascism.
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JS, 15 Aug 2015 @ 12:31am

Re: Re: Re: Re: Re:
I don't think you understand how this works.

Say you own 100 shares of stock "X". That is your long position in "X".

The market price of a share of "X" is $100.00 today.

You sell a covered call (covered by the 100 shares you own) of "X" for .50/share at a strike price of $102.00 that expires in 30 days. That is your short position in "X".

So you immediately get a premium of $50.00 from the buyer of the call minus the transaction fees.

So if the stock doesn't hit $102.00 in 30 days, the option expires and you just get to keep your 100 shares of "X" and the premium.

But, say for some reason the stock goes to $110.00 by the expiration date. You have to sell your 100 shares to the purchaser of the call at $102.00. You lose out on the additional $8.00 the stock went up. The person that bought the call gets to buy stock from you at a price of $102.00 when the market price is $110.00 earning them a profit of $800.00 minus their transaction fees and the premium they paid you.

I really don't see a way that this crashes anything, games anything or involves innocent people in any way. It's just a bet about what will actually happen to the stock price, not a manipulation of the stock price, and it only involves the seller of the call and the buyer of the call who both agreed to the deal.
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Nop (profile), 15 Aug 2015 @ 2:55am

Big Pharma has every reason to be paranoid about cheap/easy mechanisms to invalidate bad patents. Their practice of patenting minor tweaks to existing products whose patents are bout to run out ("Evergreening") could be decimated by laws like this one.
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Sheogorath (profile), 15 Aug 2015 @ 6:10am

Re: Re: Re: Re:
Shorts stock, buys low. When stock rises again, sells high. How is that not insider trading when he's using the information he gained by shorting the stock in the first place?
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Mike Masnick (profile), 15 Aug 2015 @ 6:47am

Re: Re: Re: Re: Re:
Shorts stock, buys low. When stock rises again, sells high. How is that not insider trading when he's using the information he gained by shorting the stock in the first place?

Insider trading means you know information from *inside* the company that is not yet public. Bass does not know any such info. He knows other information, but it's not insider information.

This is not, in any way, insider trading.

Nearly every stock trade is based on information that *you* believe you know that suggests the company is valued incorrectly. None of that is insider trading.
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OldMugwump (profile), 15 Aug 2015 @ 8:30am

Re: Re: It's not fraud
Yes. A "naked" short is when the short seller doesn't own a call option on the stock.

They still borrow the stock and sell it. They're called "naked" because they're 100% exposed if the stock price goes up - they'll have to buy it at the new price (no matter how high) and return it to the lender.

In a non-naked short, the short seller borrows and sells the stock, but also owns a call option on the stock. If the price rises too high, he/she executes a the option and buys the stock (to return it) at a pre-agreed price.

That limits the short seller's risk.
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OldMugwump (profile), 15 Aug 2015 @ 8:35am

Re: Re: It's not fraud
I suppose there may be some people who open margin accounts without having any idea what they're doing or reading anything about how they work (let alone the actual agreement they sign).

But anybody who does even a little research before doing this stuff learns how it works. It is in no way any kind of secret.

The SEC makes every broker who offers margin accounts (where your stock can be borrowed by a short seller) send all kinds of info to the customer to inform them.

I don't know what more you want. If people insist on paying no attention to what they're doing, of course they're going to be ignorant.
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Anonymous Coward, 15 Aug 2015 @ 9:42am

Stunning ignorance
Most of the people here are as clueless about finance as they are about patents - but that has never stopped them from spouting off like fools.

The ignorance is unbelieveable.
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Sheogorath (profile), 15 Aug 2015 @ 2:29pm

Re: Re: Re: Re: Re: Re:
Insider trading means you know information from *inside* the company that is not yet public.
Ah, okay. Thanks for clearing that up for me.
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OldMugwump (profile), 16 Aug 2015 @ 7:01am

Re: Stunning ignorance
And the people who post at TechDirt are well above average in intelligence and education. (And propensity to spout, of course.)

This is what the human race is like. Has always been like. Most people are clueless about most things.

This is the challenge for democracy - how do you get reasonable decisions out of people who on average don't know much about anything? Decisions that are not only reasonable, but also acceptable to most people (so you don't get a revolution, even if it's a revolution of idiots).

It's hard. But we could do better.
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AnonCow, 16 Aug 2015 @ 8:47am

I would argue that it is "insider trading" because he is acting before the information is publicly available.

A similar situation would be if you were an attorney that was about to file a massive liability suit against a company, so you shorted the stock before you filed the suit.
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Wendy Cockcroft, 18 Aug 2015 @ 5:56am

Wouldn't getting patents off of drugs in the first place solve the problem? R & D is already provided by universities, for the most part, and funding could be made available as a public good to determine which drugs are safe to use, etc.

Manufacturers could then make and sell the drugs, creating a more free, fair, and open market with actual competition.
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