The Big (Patent) Short

WINNER OF THE FIRST ANNUAL LASTOWKA SHORT-FORM WRITING COMPETITION IN INFORMATION LAW Carl J. Minniti III ‘17 You cannot manipulate the stock market on purpose. For example, in a classic “pump and dump” scheme, market manipulators use misleading tactics in order to inflate stock prices by convincing unwitting investors to buy. Then, once the stock price reaches its peak, the market manipulators sell off their shares at a profit. This is illegal. Similarly, in a “wash trade,” a market manipulator will simultaneously buy and sell stock, multiple times, in order to create the false impression that the stock is in high demand. This is also illegal. But what if you were to short a biotech company’s stock, then challenge the validity of the patent covering their most valuable asset, thereby causing the company’s stock price to plummet? Well, apparently you can do that. Starting in early 2015, Dallas hedge fund manager Kyle Bass—founder and principal of Hayman Capital Investment LP, a fund that made a fortune shorting the housing market in 2007—has pushed the boundaries of such manipulation. Along with notorious tech-focused patent troll Erich Spangenberg, Bass created the Coalition for Affordable Drugs and has filed upwards of thirty-five different inter partes review (IPR) petitions with the Patent and Trademark Office, challenging various pharmaceutical patents. This type of petition—a product of Congress’ concerted effort to reform patent law in the 2011 America Invents Act—allows any third-party to challenge the validity of patents under novelty and nonobviousness theories. The goal of IPR petitions was to provide an alternative forum where patent disputes could be resolved quicker and for less money than in normal federal court patent litigation. Yet, Bass has turned IPR proceedings into something no one thought they could be used for. The duo’s strategy is clear. They short stock of a publicly traded biotech firm whose revenues are concentrated on a particular drug. Then, the Coalition for Affordable Drugs will file an IPR petition in the Patent and Trademark Office asserting patents covering that drug are invalid. Once the market takes notice that the company’s patent protection is at risk, pessimism in the market will take hold and investors will start to sell off the company’s stock, thereby causing the stock price to dip. And voilà—the duo makes money because they had bet against the stock. Seem crazy? Consider the case of Acorda Therapeutics. On February 10 and 27, 2015, the Coalition for Affordable Drugs filed IPR proceedings against two of the five patents covering Acorda Therapeutic’s AMPYRA, a multiple sclerosis drug making up 90% of the company’s revenues. During that time, Acorda’s stock price fell 16.2%.  Subsequently, after the Patent and Trademark Office dismissed the challenge to Acorda’s patent on August 24, 2015, the company’s stock price immediately surged 22%. While pharmaceutical stock prices are inherently volatile investments, the mere fact that Acorda’s market value swayed with the news of the IPR petitions, shows correlation between Bass’ strategy and the firm’s stock price. Put another way, IPR petitions can affect the market. Kyle Bass and Erich Spangenberg are not oblivious to industry’s incredulity towards them—and they do not care. In fact, as hard as it may seem, the duo considers themselves Robin Hoods of Wall Street, fighting to rid the system of duplicative and unnecessary pharmaceutical patents. In a recent New York Times article, Bass argued “[s]ome patents and extensions to patents represent an unreasonable use of government regulation to enshrine monopoly power to the detriment of the public at large . . . [this] system must be fixed or we will continue to pay more and more for the same old drugs we’ve been buying for decades.” While that may be true to some extent, the fact of the matter remains—the group is shorting stocks, challenging patents and hoping the company’s stock takes a dive. Is this what IPR petitions were meant to accomplish? I think not. Therefore, it is hard to accept Bass’ argument that the purpose of the whole scheme is to lower drug prices and increase accessibility. And while that is a noble cause, it is important to note that Bass has not appealed a single IPR decision to the Federal Circuit. If he were interested in cleansing the system, then one might think he would exhaust all avenues to accomplish that end. He does not. As in all legal regimes, smart people will find loopholes in the system and use laws to their benefit. Kyle Bass is a smart guy and that is exactly what he is doing with the IPR system. But should we be surprised? Patent protection is valuable because it is a Government sanctioned monopoly. On one side of the ledger, patent holders in the pharmaceutical industry will always try to strengthen their grasp on the market, using any number of techniques, from evergreening to product hopping to exclusionary payments. Conversely, the competitors of patent holders seek ways of shortening the life of patents; one such way is IPR proceedings. This is an age-old dynamic that will be with us for as long as we have patents. Interestingly, Kyle Bass is neither a patent holder nor a competitor of a patent holder. Instead, he is somewhere in the middle and does not even participate in the pharmaceutical industry. He does not innovate new therapies and he does not manufacturer generics. Rather, Bass is a private citizen running a hedge fund, well versed in market forces. And now, with the advent of IPR proceedings and the ability for any citizen to put the validity of a patent at risk on a moments notice, he has unearthed a mechanism to sway the stock market. This is a new development touching a variety of legal regimes, from intellectual property to securities and, even, antitrust laws. Could there be room for the FTC to bring a Section 5 claim? Or could there be room for the SEC to step in and challenge the scheme as a form market manipulation? Only time will tell as commentators have just begun to take notice and offer suggestions. Importantly, there is (some) movement on Capitol Hill to address the loophole Bass is exploiting. The time may be ripe for action because, as of yet, no one else has replicated Bass’ IPR scheme. It would be naïve to think, however, that copycats will hold out for much longer.