Trade Biotech Stocks Like a Hedge Fund With These Hacks
We dance round in a ring and suppose,
But the Secret sits in the middle and knows.
–Robert Frost
The secrets of the market are out there, waiting to be unearthed. Few people have the curiosity or grit to dig for them. Sometimes, those secrets are right in front of our eyes. Few people have the boldness or presence of mind to simply look.
In the past, I’ve presented investment ideas that have been based, in large part, on discerning work to determine with near certainty whether a biotech asset is under- or overvalued (e.g. here, here, here, and here). This work requires technical proficiency, a critical eye, and the stamina for deep analysis.
I have also discussed ways in which professional investors can acquire an edge through the widespread practice of both legal and illegal insider trading. Although ethically dubious, these schemes require the cultivation of expert networks, intimate knowledge of the markets, and substantial legal wherewithal.
Most importantly, the approaches above entail a professional commitment, with a concomitant investment in time and resources, and are not accessible to the layman investor. The following are shortcuts.
The Clinicaltrials.gov Hack
Clinicaltrials.gov is a website that provides the public with information on clinical studies. The information is provided and updated by the sponsor or principal investigator of the clinical study, and the website is maintained by the National Institutes of Health. Registration is required for any Phase 2, Phase 3, or post-marketing trial of a drug, biologic, or medical device that meets one of the following conditions:
- The trial has one or more sites in the United States
- The trial is conducted under an FDA investigational new drug application or investigational device exemption
- The trial involves a drug, biologic, or device that is manufactured in the United States or its territories and is exported for research
These criteria yield essentially any trial that would materially affect the value of a publicly traded biotech company.
While the clinical trial descriptors don’t provide granular data on the status of trials (e.g. number of patients currently enrolled or proportion that have completed the protocol), they do provide an overall classification of trial status (recruiting, completed, suspended, terminated, etc.). The FDA now also requires that trials initiated from 2017 onward report results once they are available.
All told, clinicaltrials.gov is a public source of information on events that would affect most, if not all, biotech stocks. So what is the likelihood that information would be posted on clinicaltrials.gov before it is formally announced to the public in a press release? Not high, and such an occurrence would almost certainly be a blunder. But it does happen.
On February 25, 2016, clinicaltrials.gov logged a change in the study record for Vitae Pharmaceuticals’ ($VTAE) psoriasis trial of its drug, VTP-43742. The change indicated that enrollment for the trial was closed at 74 patients instead of the anticipated 108. Halting a trial’s enrollment prematurely could have a variety of causes, but very few of them would be considered auspicious. The most likely explanation, especially in an ascending dose trial, is toxicity.
On March 3, 2016, the company issued a press release noting that enrollment was closed to additional psoriatic patients, adding that data from the enrolled cohort would be “sufficient to determine next steps in the program.” This revelation was viewed negatively by the market, and the company’s stock plunged 52% the following day.
Vitae later reported that the drug demonstrated positive efficacy in the trial, causing its stock to regain much of its lost ground. However, recruitment had in fact been halted due to toxicity concerns, as investigators in the trial observed transaminase elevations in four patients in the 700-mg group, which swayed Vitae to forgo the highest dose cohort of 1,050 mg.
A similar case manifested on March 23, 2016, when clinicaltrials.gov registered a change in the study record for Ionis Pharmaceuticals’ ($IONS) trial of drug IONIS-TTR(Rx) in familial amyloid polyneuropathy (FAP). The change signaled that enrollment of the Phase 3 trial was halted at 172 patients, instead of the planned 195. On April 7, 2016, Ionis issued a press release stating that the FDA placed its planned trial of IONIS-TTR(Rx) in transthyretin amyloid cardiomyopathy on clinical hold, due to an undisclosed issue with its ongoing trial in FAP. Ionis promptly shed 11% of its value. It was later revealed that the clinical hold was triggered by a negative safety signal from the FAP trial, in which some patients experienced a severe decline in platelet count.
To be fair, changes to clinical trials don’t always foreshadow bad news. Trials are sometimes stopped early due to efficacy (which would trigger unblinding of the trial in order to treat all patients with efficacious drug). This was famously the case for Intercept Pharmaceuticals’ ($ICPT) trial of obeticholic acid in nonalcoholic steatohepatitis, where the announcement sent the company’s stock soaring over 500%. But trials can also be stopped due to lack of efficacy, toxicity issues, or simply poor enrollment. In an analysis of terminated studies on clinicaltrials.gov, 68% of trials were terminated due to reasons other than scientific data from the trial (e.g. insufficient rate of enrollment, issues with study conduct), and only 21% of trials were terminated due to findings related to the overall benefit-risk profile of the intervention. Only a subset this 21% would be trials that are stopped due to positive efficacy.
Thus, a potentially lucrative trading strategy would be to
(1) troll clinicaltrials.gov for recent updates to clinical trial records where the sponsor is a publicly traded biotech company,
(2) determine whether the update is material to the company’s stock price,
(3) verify whether a press release has already been issued and, if not,
(4) trade in the company’s stock.
The most straightforward embodiment of this strategy a short of the stock of a company whose trial is terminated, suspended, or for which recruitment is halted without a relevant disclosure by the company. The risk is that the change in the trial is due to a positive development (which we’ve determined is unlikely) or that the change is actually immaterial and some other, positive catalyst emerges in the meantime. If you’re convinced the change is material but could be positive, consider hedging your position with a call option to the upside.
You may be thinking that, with over 250,000 trial records on clinicaltrials.gov, monitoring each trial in real-time would be a futile effort. Fortunately, the web site recently implemented an RSS feature which, with some customization, allows you to automate this process. The RSS feed can automatically update you to recently added or modified study records of interest. For instance, a search for all interventional studies with the status Active, not recruiting, Suspended, Terminated, or Withdrawn, yields 31,010 study records.
- Click on Subscribe to RSS in the upper-right corner of the search results box:
2. A pop-up box containing RSS feed options will appear. Choose the option for Show studies that were added or modified in the last 14 days, and click on the Create RSS Feed button to open the feed and display a list of any new updates to your search results.
You can subscribe to the RSS feed using your browser or a feed reader (e.g. Feedly). Once you set up an RSS feed on your browser or feed reader, you can integrate with IFTTT to set up e-mail or push notifications and receive any relevant update in real-time. Now, I’m notified immediately of any clinical trial that is terminated, suspended, or that stops recruiting.
The FOIA Hack
Sometimes, when you don’t have the answer to a question, the government will give it to you. The Freedom of Information Act (FOIA), signed into law in 1966, gives any person the right to access public records, such as FDA facility inspections, drug adverse event reports, and internal newsletters. We fund government, and they collect a lot of data on people, corporations, and their products. The FOIA allows the average taxpayer to access that data.
Trading on material obtained through FOIA is not illegal because the government has no duty to keep the information private — in fact, officials are required to disclose the information, except when its release poses a threat to national security. Some federal agencies are bound to protect certain trade secrets, such as the proprietary manufacturing protocol for a drug, in which case the agency will withhold or redact such information.
Hedge funds already make liberal use of FOIA to perform due diligence, with several examples of such funds profiting or stemming losses based on the information they obtained. In March of 2009, Genzyme announced that the FDA had issued a warning letter identifying manufacturing deficiencies at a plant where it produced the enzyme replacement therapies Cerezyme and Fabrazyme. SAC Capital sent a FOIA request to the FDA for the Form 483 facility inspection report, which it received on March 30. The report led SAC to believe that the issues were more dire than the company let on because, over the next few months, SAC reduced their stake in the company from 221,000 shares to 127,000. On June 16, the company disclosed a viral contamination at the plant, leading to manufacturing shutdown of the two drugs. SAC was able to avert major losses, as the company’s stock declined 15% in the two weeks ending June 16.
Another FOIA exploit enabled hedge funds to predict the acquisition of Actelion by Johnson & Johnson earlier this year. Although Actelion had been a rumored takeover target for some time, a group of hedge funds became increasingly convinced when they found that J&J’s corporate jet had been parked in Basel, Switzerland — near Actelion headquarters — for over a week. When the $30 billion deal was announced on January 26, 2017, Actelion’s stock soared 20%, earning the funds hundreds of millions in profit.
The story echoes a scene straight out of the movie Wall St — but these funds didn’t need to rely on corporate espionage à la Bud Fox for this intel. The movements of almost any private jet can be tracked using publicly available tools, thanks to FOIA. The FAA keeps track of all aircraft, and because of FOIA, the FAA has agreed to provide the data in real-time to services such as FlightAware. The only information needed to track a plane is the tail number for the specific jet, which can be searched on the FAA registry using the owner’s name.
These feats are not merely anomalies. A recent analysis found that FOIA requests are incredibly common among hedge funds. (Incidentally, the study’s authors used none other than a FOIA request in order to acquire the data on FDA-bound FOIA requests). A separate analysis broke down the 1,899 FOIA requests of FDA records by hedge funds from 1999 to 2013, and found that the most frequent kinds of requests were for Form 483s and consumer complaints.
In addition to being frequently invoked, FOIA enables hedge funds to generate significant trading returns. In particular, when funds increase their holdings of a stock in connection with a FOIA request, the stock’s abnormal returns (a measure that adjusts for market trends) average 5.26%, and when funds reduce their holdings, abnormal returns average -3.09%. In other words, the trades associated with FOIA requests are, on average, profitable, underscoring the value of the information.
FOIA requests give rise to information asymmetries. Even though the information is accessible to anyone, it is not publicly disseminated, and only those who request it will benefit from it. Although there has been an effort to make a searchable, online database of the over 600,000 yearly FOIA requests and responses (i.e. FOIA Online), the Department of Health and Human Services, which oversees the FDA, does not participate in the program. Moreover, the FOIA information comes in the form of unfiltered technical reports, and only those that can understand and process the information can effectively exploit it.
Currently, I’m working to create a database of material obtained through FOIA requests to the FDA. The purpose is to give biotech investors access to public information that is, ironically, inaccessible to the independent investor. I’m aiming to crowdsource the database by, at least initially, requiring users to submit FOIA information in order to gain access. If readers are interesting in learning more about this project, please provide your contact information here.
Submitting a FOIA request is quite straightforward. The FDA has an online request form through which you can submit your request. The form will ask you the maximum dollar amount you are willing to pay for processing. For consumer use, there is no charge for the first two hours of search and the first 100 pages of information, which should be sufficient for most requests. Beyond that, modest search and copying fees apply. There will be a field where you can enter your request or upload it as a document — be as specific as possible. Remember, you may ask for anything within reason (e.g. adverse event reports, warning letters, facility inspection reports).
You may also want to include with your request a note asking the agency to contact you by e-mail or phone in case of any questions, as requests can be denied for being unclear. Finally, you should ask to have the information sent in PDF format by e-mail so that the agency doesn’t default to snail mail. All agencies are required to respond to your request within 20 business days, although the information may take and additional 10 days in exceptional circumstances. It’s as simple as that!
The above tools are some of the most accessible and reliable ways the independent investors can leverage information asymmetries in the biotech markets. It hardly needs to be said that, by revealing them as I have, I’ve diminished the personal advantage these methods afford me. However, there is also a benefit to me in democratizing these tools, because even as they make the markets marginally more efficient, they increase the value of the other tools in my toolbox. As for those, they’ll just need to wait for a future article.
