Down-Round Financing

By Adrian Rich, Associate (Palo Alto Office)

The continuing economic downturn has made raising money more difficult, driving down valuations and making down-round financings more common for reasons that may be wholly unrelated to the company’s progress and ultimate value proposition. At a time when “flat is the new up” has become a common saying, companies seeking equity investment in the near term must be aware of the possibility that investors will only be willing to invest at a lower valuation than the previous round and the consequences that may result.

Of primary concern is dilution. Although all investment-round financings will dilute both the economic and voting interest of the existing stockholders, dilution during a down-round financing is greater than during an up-round financing, both because more shares are issued in a financing at a lower price and, in many instances, because of the effect of so-called “anti-dilution adjustments” that can increase the relative ownership of some existing stockholders at the cost of additional dilution to founders, management, and early, lower-priced investors. 

In addition to dilution, the current investing environment is giving rise to more investor-favorable terms, designed to enhance returns and/or provide additional protections to new investors. Although agreeing to these terms might attract new investors, companies should be aware that some of these terms may hinder the existing shareholders’ ability to get value out of a company upon a liquidity event. Provided below are several terms commonly used in today’s dilutive financings. 

Financing Terms in a Down Round

• Liquidation preference.  Liquidation preferences determine the order in which investors will be paid out during a sale or winding up of the company (e.g., typically, preferred stockholders will be paid out prior to common stockholders; holders of senior series of preferred stock will be paid out prior to holders of subordinate series of preferred stock). In more typical times, preferred stock would have a liquidation preference equal to the purchase price, and an investor would have to choose between taking the liquidation preference or converting to common stock and participating with holders of common stock. In today’s market, a highly dilutive financing may involve the issuance of uncapped participating preferred stock with senior liquidation preferences at multiples of the purchase price.
  
  
  • If the aggregate amount of liquidation preferences for preferred stockholders reaches a level that equals or exceeds the value of the company, the common stock may be seen as worthless. This could have a severe impact on the motivation of the employees and management, who often hold most of the common shares.
    
    
  • When negotiating in a down round, the company should try to structure liquidation preferences in a manner that both attracts new investors and keeps existing employees and management adequately motivated. To maintain this balance, some down-round financings involve a conversion of previously issued preferred stock into common stock in order to decrease the aggregate liquidation preference.
    
    
• Full-ratchet or weighted-average anti-dilution protection.  Anti-dilution clauses determine who will bear the burden of a future down round. A full-ratchet anti-dilution provision provides the investor with additional shares so that the investor is treated as if his or her investment was made at the lower price at the expense of the existing investors. In contrast, a weighted-average anti-dilution provision distributes losses more evenly between new investors and existing investors by taking into account the size of the new offering and price paid relative to the company’s capitalization and amounts previously paid for shares.
  
  
• Milestone-based or tranched financing.  Investors may be reluctant to invest large amounts of money in a risky financing in one closing. Instead, they may provide enough money for a company to achieve a particular milestone to raise additional funds. This is especially common in this economic environment where venture funds have pressure from their limiteds to delay or reduce capital calls. Tranched financing may be an appealing option to both the new investors and the company. In a tranched financing, new investors are able to secure an investment opportunity, often at a lower valuation, without being required to provide the company with all of the financing upfront. Tranched financing also reduces the company’s near-term financing risk, as the company will not be required to find new investors at the next funding event, assuming the milestones are met. 
  
  
• Pay to play.  Dilutive financings often implement a pay-to-play provision that penalizes stockholders who do not participate in the financing. For instance, a non-participating stockholder might be forced to convert his or her shares into common stock or lose certain rights such as anti-dilution protection. Absent a pay-to-play provision, stockholders may not have an incentive to risk additional capital in the company.
  
  
• Enhanced rights for participating investors.  In some financings, existing stockholders who participate in the financing may receive additional benefits over non-participating stockholders. Such benefits may include having their preferred stock repriced via an adjustment to the conversion ratio or exchanging their existing shares for new preferred stock shares with more favorable rights (e.g., senior liquidation preferences). 
  
  
• Expanded investor protections.  Some investors may request expanded protections such as more extensive representations and warranties, broader indemnification protection, D&O insurance, drag-along rights, and redemption features.

Sharing the Pain

Although holders of common stock are often most severely affected by the terms of a down-round financing, companies should be aware that there are ways to counteract the effects of these pro-investor provisions. For instance, keeping management and employees incentivized is essential to the success of a start-up. In situations where aggregate liquidation preferences have rendered the common stock nearly worthless, management can seek the creation of so-called “carve-out” plans, which set aside a specified percentage (typically around 5-10 percent) of proceeds distributable to shareholders in a sales transaction. Similar plans, called “employee retention plans,” may be implemented to hire and retain employees. Properly conceived plans may keep management and employees motivated after a down-round financing by allocating to them a meaningful portion of the proceeds paid out of a company exit. These plans, however, have a number of drawbacks, including adding complexity to the capitalization structure and having no possibility of long-term capital gains for the beneficiaries of the payouts on any liquidity event.

In addition to carve-out and employee retention plans, management can and often does advocate for a sizeable option-pool increase. An option-pool increase, coupled with a promise from investors to support an allocation of “refresh” options to management and key employees, can fully or partially offset the dilution created by the down-round financing. 

Down-round financings also may provide management with an opportunity to renegotiate their employment packages to include additional downside protections for themselves. Terms that may be appropriate for discussion include meaningful cash-based severance, accelerated equity vesting, and post-termination continuation of benefits upon termination of employment without cause or upon a constructive termination.

Alternative Financing Structures

Companies that feel they are not properly valued by potential investors in the current economic environment also may consider alternative financing structures. One such structure is a convertible note and warrant financing. This type of financing allows the parties to postpone establishing the company’s enterprise value while the debt is outstanding until a later date when the note converts to equity. Although these financings can be cheaper and faster to close than a typical preferred stock financing, companies should be aware that note and warrant financing terms have also recently become more investor-favorable, with high multiples of return, expensive equity kickers, and the inherent priority on repayment over stockholders. 

Insider-Led Financings

When raising money becomes difficult, existing investors are often left to fund a company. In such situations, the role of participating inside investors (who have the ability to both set the investment terms and make the investment) may be unsettling for management, founders, and minority stockholders. There are several steps the board and company may take to reduce the risk of litigation from disenchanted stockholders. 

• A compelling board record. Board minutes reflecting the board’s thinking and analysis are important. The minutes should reflect the board’s rationale for considering a down-round financing and its efforts to recruit new investors.
  
  
• Diligent assessment of alternatives. The board should attempt to demonstrate that it has considered all reasonable alternatives to the insider-led round. Although not legally required, the company should engage new investors even if it anticipates unfavorable terms—make the investor say “No.”
  
  
• Approval by independent directors. Approval of the financing terms by the independent directors will likely be given more weight by the courts than a decision made by directors that may be influenced by conflicting financial interests.
  
  
• Disinterested stockholder approval. Securing the approval of the stockholders who are not participating in the financing helps the company defend against an attempt by disenchanted stockholders to void the transaction.     
      
• Full disclosure of terms. Complete disclosure of financing terms is essential in a down round, particularly with respect to the benefits of the financing terms to the inside investors, the likelihood of replenishment of equity incentives to management and employees following completion of the financing, and factors that would adversely impact non-participating stockholders.
  
  
• Rights offering. Companies should consider offering stockholders, including any employees with vested options and warrant holders with “in the money” rights, the opportunity to participate in the financing on substantially the same terms as the inside investors. This broad offering may introduce additional securities law compliance issues that must be taken into account. 

Conclusion

When seeking venture funding in the current economy, companies must be aware of and prepared to deal with dilutive financings and any litigation that may follow. Although investors likely will have negotiating leverage on deal terms, companies should recognize that they have tools to protect their interests as well. Legal counsel that is both skilled and highly acquainted with the venture financing market can be an invaluable resource to assist companies during this process.

Adrian Rich (650) 849-3367 arich@wsgr.com

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Government’s Rights to Federally Funded Inventions under the Bayh-Dole Act

By Yang Yang, Law Clerk, and Ian Edvalson, Partner (Palo Alto Office)

Introduction

The Bayh-Dole Act was enacted in 1980, in part to promote the utilization of inventions resulting from federally funded research. It provides universities, nonprofit organizations, and small and large¹ businesses alike the option to retain ownership of inventions developed with federal funds and profit from commercializing these inventions.² In exchange, the recipients of such funding must comply with certain requirements to disclose and commercialize these federally funded inventions.³ The Bayh-Dole Act also reserves certain rights for the government to protect the public against the nonuse or unreasonable use of inventions developed with federal funds.

Before the enactment of the Bayh-Dole Act, when agencies generally retained title to the inventions they funded, less than 5 percent of government-owned patents were used by the private industry, according to an audit conducted in 1979. Since its enactment, the Bayh-Dole Act has been widely credited for the substantial increase of technology transfer from the public sector to the private sector. However, while most universities and research institutions have fully embraced the opportunities provided by the Bayh-Dole Act, some private companies, in particular start-ups and venture-backed companies, remain reluctant to take advantage of federal funding opportunities. The concern seems to be that the patent holder or exclusive licensee of a federally funded invention may not receive the expected market monopoly because of the rights that are retained by the government in the invention. This article analyzes the rights retained by the government under the Bayh-Dole Act and discusses the practical implications related to such retained rights for the development and commercialization of biomedical products based on federally funded inventions.

Nonexclusive and Royalty-Free Licenses

Under the Bayh-Dole Act, the government retains “a nonexclusive, nontransferable, irrevocable, paid-up license to practice or have practiced for or on behalf of the United States any subject invention throughout the world.”⁴ A “subject invention” is defined as any invention “conceived or first actually reduced to practice in the performance of work under a funding agreement.”⁵ Despite its seemingly broad scope, this license is practically limited in several ways. First, the government’s rights under this license attach only to a subject invention itself and do not extend to subsequent inventions based on the subject invention. Second, the license does not extend to the final commercial products that embody a subject invention or any “proprietary information or trade secrets” that may be incorporated into such products.⁶ Finally, the government’s license under the Bayh-Dole Act is nontransferable and can only be exercised to meet needs that are reasonably related to the requirements of the federal government. Although the government could exercise its retained license to manufacture or authorize a third party to manufacture a product containing a subject invention on behalf of the government, such manufacture must satisfy a legitimate federal government need. Further, if the product or the manufacturing process used to make the product contains technologies that were not developed with federal funds, the government would need to obtain a license to use them.

In practice, the government’s exercise of its retained licenses to inventions in the biomedical field has been very limited. According to a report by the U.S. Government Accountability Office (GAO) in July 2003, the federal government exercised its retained licenses to inventions in the biomedical field primarily for research purposes.⁷ The licenses are valuable because they allow government researchers to use the inventions without concern about possible challenges for unauthorized use. On the other hand, according to the procurement officials at the Department of Veterans Affairs (VA) and the Department of Defense (DOD), the government’s licenses under the Bayh-Dole Act have never been used by any federal agency to procure or manufacture products for biomedical applications.⁸

March-In Rights

In addition to the nonexclusive, royalty-free license to practice the subject invention, the Bayh-Dole Act also provides the government with what are known as “march-in” rights, which allow the federal agency that funded the development of an invention to require the patent holder or exclusive licensee of the invention to grant a license to a responsible third-party applicant if the agency determines that:

• the patent holder or exclusive licensee has not taken, and is not expected to take, effective steps to achieve practical application of the subject invention; or
  
  
• public health or safety needs are not reasonably satisfied by the patent holder or exclusive licensee; or
  
  
• the use of the subject invention is necessary to meet requirements for public use specified by the federal government and the patent holder or exclusive licensee cannot meet the requirements; or
  
  
• products embodying the subject invention or produced through the use of the subject invention are not being “manufactured substantially in the United States” and the patent holder or exclusive licensee has not obtained the necessary waivers of such requirement.⁹

These march-in rights have caused considerable concern about the potential dilution of commercial rights in such inventions. However, according to a GAO report issued in July 2009, none of the four major federal funding agencies—the DOD, the Department of Energy (DOE), the National Aeronautics and Space Administration (NASA), and the National Institutes of Health (NIH)—has ever initiated a march-in proceeding or exercised its march-in authority during the 28 years since the Bayh-Dole Act became effective.¹⁰ Specifically, the GAO has identified the following key disincentives for federal agencies to use their Bayh-Dole march-in authority:

• The potential chilling effect of a march-in action could deter private-sector researchers from participating in federal research efforts and investors from investing in the commercialization of the research results.
  
  
• The lengthy march-in process developed by the Department of Commerce¹¹ makes it difficult for agencies to carry out a march-in proceeding.
  
  
• In cases where commercial products or processes employ multiple technologies and only some of them have been developed with federal funding, “marching in” on those federally funded inventions would not serve its intended purpose.
  
  
• The current patent holders or exclusive licensees may have specialized knowledge that makes them particularly well positioned to bring a product to market, and the loss of such knowledge through a march-in proceeding might jeopardize the commercialization of a subject invention.¹²

In fact, the NIH has been petitioned formally three times to exercise its march-in rights, but in each case it determined that the statutory requirements for march-in proceedings had not been met. Specifically, in 1997, CellPro, Inc., petitioned the NIH for a patent license it was accused of infringing.¹³ CellPro developed a stem cell selection device and obtained Food and Drug Administration (FDA) approval for use of its product. Baxter Healthcare Corporation was also developing a similar device under its exclusive license to a NIH-funded invention. Baxter Health sued CellPro for patent infringement and won. In its petition, CellPro alleged that Baxter failed to achieve practical application of the subject invention because Baxter’s product had not yet been approved, and that the public health and safety needs were not satisfied because Baxter refused to grant a license to CellPro to sell the only FDA-approved product. The NIH found no basis to initiate a march-in proceeding because it determined that by working to obtain FDA approval for its own product and making its product available to patients through clinical trials, Baxter had satisfied the requirements under the Bayh-Dole Act. In 1999, the NIH rejected a request to grant licenses to the World Health Organization to use U.S. government-funded medical inventions.¹⁴ In his public letter, then-NIH director Harold Varmus stated: “As a practical matter, it is reasonable to assume that companies will not undertake the development costs of these inventions if they believe the government will readily allow third parties to practice the inventions.”¹⁵ In 2004, the NIH received two similar petitions to invoke the march-in rights, in which the petitioner expressed concern that the price of two drugs—Norvir to treat HIV/AIDS and Xalatan to treat glaucoma—made them unaffordable for many people living with these diseases, posing a threat to public health and safety.¹⁶, ¹⁷ Again, the NIH determined that both drugs were already on the market and widely prescribed, and therefore had reached practical application and met health and safety needs as required by the Bayh-Dole Act. The NIH specifically stated in its decisions that drug pricing is an issue more appropriately left to Congress. The NIH’s decisions on these three petitions, together with its public pronouncement, have firmly established a precedent of extreme caution in the exercise of march-in rights.

Other Considerations

It is worth noting that recipients of U.S. government funding who elect to retain ownership of a subject invention must comply with certain disclosure, reporting, and filing requirements.¹⁸ Failure to disclose the subject invention, elect title to it, or file a patent application within the prescribed times, or failure to follow through with the patent application process, would allow the relevant federal agency to obtain ownership of the invention. In 2004, the Federal Circuit held in Campbell Plastics Eng’g & Mfg. Inc. v. Les Brownlee that funding recipients must strictly follow the specific reporting requirements of the Bayh-Dole Act in order to retain title to their inventions.¹⁹ Therefore, strict compliance with these procedural requirements is necessary to ensure preservation of rights with respect to a subject invention.

Finally, the Bayh-Dole Act also requires that products embodying a subject invention be manufactured substantially in the United States.²⁰ Failure to comply with this requirement would trigger the funding agency’s march-in rights described above. However, such requirement applies only to inventions that are not subject to a waiver from the requirement by the funding agency. To waive the obligation, the patent holder or exclusive licensee must demonstrate to the funding agency that “reasonable but unsuccessful efforts” were made or that domestic manufacturing is “not commercially feasible.”²¹ The factors that make domestic manufacturing not commercially feasible include the relative costs of U.S. and foreign manufacturing.

Conclusion

In summary, the government’s rights to federally funded inventions retained under the Bayh-Dole Act are limited, and the federal government has been extremely cautious in exercising such rights. As long as funding recipients follow the procedural and other requirements provided in the Bayh-Dole Act, federal research and development grants provide an excellent source of non-dilutive financing for start-ups and venture-backed companies, especially those in the biomedical industry, to develop and commercialize their products.

We would like to thank Omar Alam for conducting some of the research referenced above and Shakti Narayan for his helpful comments to this article.

¹ Exec. Order No. 12,591, 52 FED, REG. 13,414 (1987) (The Bayh-Dole Act was expanded to apply to all federally funded inventions arising under funding agreements with all contractors “regardless of size.”)
² 35 U.S.C. §202(a).
³ 37 C.F.R. Part 401.
⁴ 35 U.S.C. §202(c)(4).
⁵ 35 U.S.C. §201(e) (“Funding agreement” is defined under 35 U.S.C. §201(b) as, with limited exceptions, any contract, grant, or cooperative agreement entered into between any federal agency and any contractor for the performance of experimental, developmental, or research work funded in whole or in part by the federal government.)
⁶ NIH Office of Technology Transfer, Polices and Guidelines, http://ott.od.nih.gov/policy/policy_protect_text.html.
⁷ U.S. Government Accountability Office, Report to Gong. Comm., Technology Transfer: Agencies’ Rights to Federally Sponsored Biomedical Inventions (July 2003).
⁸ Id.
⁹ See 35 U.S.C. §203.
¹⁰ U.S. Government Accountability Office, Report to Gong. Comm., Information on the Government’s Right to Assert Ownership Control over Federally Funded Inventions (July 2009).
¹¹ See 37 C.F.R. §401.6.       
¹² See Supra 8.
¹³ NIH Office of the Director, Determination in the Case of Petition of CellPro, Inc., (Aug. 1, 1997).
¹⁴ Letter from NIH Director, Dr. Harold Varmus to Ralph Nader, James Love, and Robert Weissman responding to their request calling on the NIH to provide the World Health Organization, WHO, access to U.S. government funded medical inventions (Oct. 19, 1999), http://www.cptech.org/ip/health/sa/varmusletteroct19.html.
¹⁵ Id.
¹⁶ NIH Office of the Director, In the Case of Norvir Manufactured by Abbott Laboratories, (Jul. 29, 2004).
¹⁷ NIH Office of the Director, In the Case of Xalatan Manufactured by Pfizer, (Sept. 17, 2004).
¹⁸ 35 U.S.C. §§202(c)(1)-(3).
 ¹⁹ See Campbell Plastics Engineering & Mfg. Inc. v. Les Brownlee, 389 F.3d 1243 (2004).
²⁰ 35 U.S.C. §204.
²¹ Id.

Yang Yang (650) 565-3625 yyang@wsgr.com

Ian Edvalson (650) 849-3395 iedvalson@wsgr.com

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U.S. Supreme Court to Review the Federal Circuit’s One-Size-Fits-All Test for Patent Eligibility of Process Claims

By Ray Akhavan, Associate (Washington, D.C., Office)

On June 1, 2009, the Supreme Court of the United States agreed to review a ruling set forth by the U.S. Court of Appeals for the Federal Circuit in In re Bilski, 545 F.3d 943 (Fed. Cir. Oct. 30, 2008). The underlying patent in question in Bilski contains business-method claims, and the Federal Circuit held that the patent is invalid for failure to satisfy the subject matter requirements of 35 U.S.C. § 101. Patent eligibility is one of the most fundamental questions in patent law and is addressed under § 101, which states “[w]hoever invents or discovers any new and useful process, machine, manufacture, or composition of matter, or any new and useful improvement thereof, may obtain a patent therefor, subject to the conditions and requirements of this title.” Reasonable concerns are borne by many parties as to whether business-method claims should be patent-eligible under § 101. However, the more salient point for life science innovators is whether the Federal Circuit’s decision in Bilski will negatively impact diagnostic or prognostic patent claims—and the answer is yes.

Molecular Diagnostic Process Claims

While the underlying patent claims in Bilski were directed to business-method claims for hedging risk, the Federal Circuit’s holding extends to all process claims with a rigid and putatively exclusive test that can remove useful and novel diagnostic claims from patent eligibility. Therefore, the decision can have ramifications across all life science technology sectors, including molecular diagnostics. The Federal Circuit’s one-size-fits-all test—known as the “machine-or-transformation test”—for assessing the patent-eligibility of process claims permits a process to be patented only if: (1) it is tied to a particular machine or apparatus, or (2) it transforms a particular article into a different state or thing. The Federal Circuit also noted that the test is satisfied only if machines and transformations are not merely part of “insignificant extra-solution activity,” such as gathering data, and that merely adding a “field-of-use” limitation does not render an otherwise ineligible method claim patent-eligible.

Molecular diagnostic tests have been increasingly recognized as important, if not absolutely necessary, tools for providing better healthcare and improving patients’ well-being by providing a personalized medicine approach in both diagnostics and treatment. Generally, such processes involve the application of genomic and molecular data for enhanced diagnosis and treatment of disease, often by assessing a sample from an individual patient to determine the presence of one or more biomarkers. A “biomarker” is generally any substance that can be assessed as an indicator of a biological state, which can include normal, pathogenic, or pharmacologic responses to a therapeutic intervention. Typically, a biomarker is a particular protein or nucleic acid (e.g., RNA or DNA) molecule. Therefore, the presence or level of such biomarkers is correlated with a diagnostic or prognostic outcome to provide a personalized medicine approach to treating a patient for various disorders, including cancer and autoimmune disorders. Based on an individual patient’s biomarker profile, a clinician can detect disease or determine the best therapeutic regimen.

Indeed, personalized medicine provides a more effective and economical use of healthcare resources to improve patients’ well-being and ultimately to save lives. Such molecular diagnostic processes require substantial investment of intellectual and financial resources. As such, investors and scientists pursuing such innovations in personalized medicine must rely on the protection of any corresponding intellectual property through established patent law jurisprudence.

Based on the substantial investment of financial and intellectual resources that are typical of many biotechnology research and development programs, there is a rapidly growing body of information related to biomarkers and their correlation to various diseases. Molecular diagnostic companies that rely on patent exclusivity based on the discoveries of biomarkers or their significance for a particular disease or condition will face uncertainty as to whether patent claims to related processes will be patentable under the machine-or-transformation test. Molecular diagnostic claims often are directed to a method for providing a diagnostic or prognostic outcome by determining whether a biomarker is present and, if present, at what levels, and correlating such determinations to a particular disease or treatment outcome. Furthermore, the translation of such discoveries to patents is often in the form of “process claims” that define which biomarker is assessed and to which outcome or condition the biomarker is correlated. Such claims are clearly distinguishable from the claims directed to hedging risk in commodities trading, which were at issue in Bilski.

Application of Bilski Process Claims

The United States Patent and Trademark Office (USPTO) has issued guidance to examiners that the machine-or-transformation test should be applied to all process claims. Indeed, the USPTO has begun rejecting diagnostic process claims based on the machine-or-transformation test. For example, Claim 1 of U.S. Patent Application No. 10/888,180 (the ’180 application) is directed to a method for determining whether an individual suffers an endometrial pathology by detecting a plurality of polypeptides in a test sample to obtain a test profile that is compared to a reference profile (available at www.uspto.gov/external/portal/pair).

The USPTO rejected Claim 1 as being directed to non-patentable subject matter under § 101, because it did not pass the machine-or-transformation test. In the Office Action rejecting the claim, the examiner stated that “the claimed subject matter recites steps for obtaining a patient sample and detecting polypeptides...[but that]...these limitations do not require any assays for performing these steps and therefore do not explicitly result in a transformation of an article.” (Id., Office Action mailed July 7, 2009, page 4). Therefore, the Bilski test would require narrowing amendments to particular assays or machines, where depending on the detecting step, any number of conventional assays can be used. Such amendments would belie the key point of the invention, which typically is not that a particular assay is used to detect a biomarker, but that the detection of a biomarker is correlative to a diagnostic or prognostic outcome.

In addition, the machine-or-transformation test already has formed the basis for invalidating medical diagnostic and treatment process claims. In particular, in a three-sentence unpublished opinion, the Federal Circuit affirmed a lower court ruling invalidating diagnostic and treatment claims for failing to be tied to a particular machine or reciting a transformation of a particular article to a different state or thing. [See Classen Immunotherapies, Inc., v. Biogen IDEC, 304 Fed. Appx. 866, 867 (Fed. Cir. 2008).]

Patent Claim Strategy

If the Supreme Court affirms the Federal Circuit’s narrow and limiting test, medical diagnostic companies will need to develop new strategies to overcome rejections at the USPTO, as well as to rebuff invalidity challenges.

With respect to patent claims, diagnostic companies can reduce the likelihood of USPTO rejections of molecular diagnostic claims by including one or more particular assays that are utilized to obtain information from a patient sample. For example, a claim for diagnosing a disease or prognosticating an optimized treatment regime can include the particular methodologies utilized to determine the presence or measure the level of a biomarker, such as by amplifying or sequencing a nucleic acid molecule obtained from a patient sample (e.g., real-time PCR, immunohistochemistry, or gene expression analysis utilizing DNA chips). In addition, applicants also can argue before the USPTO that diagnostic claims necessarily implicate transformative steps, and thus pass the transformative prong of the Bilski test. As such, there should be no need to recite particular conventional methods for detecting a protein or a nucleic acid molecule.

With respect to issued patents being challenged in litigation, depending on the claim at issue, a patentee can assert that the detection of a biomarker, coupled with a subsequent correlation to a predisposition for either developing a disease or amenability to a particular treatment, invariably implicates transformative steps and/or use of a particular machine. For example, the detection or determining step in a diagnostic or prognostic process claim embodies the transformative step of combining two nucleic acid molecules binding to each other or an antibody binding to a target protein, as well as machines used to detect such reactions (e.g., DNA chip).

Conclusion

As a result of the changes taking place in IP law, molecular diagnostic companies need to ensure, even more than before, that patent claims and supporting applications include ample examples of technologies utilized to measure or detect biomarkers.

Ray Akhavan (202) 973-8832 rakhavan@wsgr.com

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Revised NYSE Initial Listing Standards Provide Greater Choice for IPOs

By Philip Oettinger, Partner (Palo Alto Office), and Brian Curran, Managing Director, Global Corporate Client Group, NYSE Euronext

Many medical device companies that had planned to be public companies by now are holding off on their IPOs until market comps and valuations improve. The market is open, however, for high-growth companies tracking toward $100 million in revenue with at or near break-even performance. Historically, the standard preference for medical device companies going public has been to list on the Nasdaq Stock Market due to the inability of most medical device companies to meet the New York Stock Exchange (NYSE) listing standards. That may be about to change.

According to The Wall Street Journal, the NYSE is scoring victories in its battle to wrest listings of initial public offerings away from Nasdaq. As of August 2009, the NYSE held a nearly 2-to-1 advantage over Nasdaq among companies going public this year, with 11 of 18 companies (61 percent) listing on the NYSE.

Many of the differences between the NYSE and Nasdaq have diminished as trading has moved to electronic platforms. A decade ago, the NYSE’s specialist system relied on greater human input, while Nasdaq could argue that its electronic system of multiple market makers was more tech-savvy. Recently, the NYSE has deployed a fast, automated, anonymous order-execution system in which average executions take 6 milliseconds and the trading system can handle over 10 billion shares trading in a single day. At the same time, the NYSE has retained elements of the personal touch that it had with the specialist system, through what it calls the Designated Market Maker System (DMM). The DMM has the obligation to provide a quote at the National Best Bid and Offer (NBBO) during a specified percentage of the time and to maintain orderly markets. In addition, the DMM facilitates price discovery during the market opening and closing, assists with block trades, and provides capital to ensure liquidity during temporary imbalances. The DMM also serves as an information resource for company management. Additionally, in contrast to Nasdaq, the NYSE cedes control to the issuer’s bookrunners for the timing of opening trading in an IPO, which provides improved pricing/distribution efficiencies and mitigates intraday volatility on the first day of trading. Collectively, these changes have provided the NYSE with a very attractive platform for supporting IPOs and follow-on trading.

Most importantly, the NYSE has lowered its listing standards to become more competitive with Nasdaq. The NYSE has eliminated its Arca platform for IPOs so that companies that now list with the NYSE get the caché of being listed directly on the Big Board. Of note, the NYSE has provided an alternative for listing on the Big Board that focuses on an asset and equity test. To satisfy this alternative, a company must only have a market capitalization of $150 million, total assets of $75 million, stockholders’ equity (assets minus liabilities) of $50 million, and a minimum share price of $4.00 per share.

A couple of tech companies that have taken advantage of the revised NYSE standards serve as representative case studies. 3PAR applied for listing under the NYSE Arca standards. After meeting those standards, it was listed on the NYSE Arca platform and migrated to the Big Board in December 2008 when the NYSE dispensed with the Arca listing process. NetSuite similarly began the process of applying to list under the NYSE Arca platform but eventually qualified for listing on its own under the Big Board’s initial listing standards.

Additionally, the NYSE completed its acquisition of the American Stock Exchange in October 2008, and has re-branded this platform as NYSE Amex. NYSE Amex was upgraded to run on the same technology platform as the NYSE Big Board, and includes the same market structure and DMMs. NYSE Amex listing standards are even broader than those of the NYSE Big Board.

The NYSE has yet to have a medical device company go public under the revised Big Board or NYSE Amex standards. It is rumored that several companies are considering an NYSE listing and it may only be a matter of time until the NYSE obtains its first medical device company IPO.

*The complete set of initial listing criteria for the following exchanges may be viewed where indicated below:

Nasdaq Stock Market: http://www.nasdaq.com/about/nasdaq_listing_req_fees.pdf
New York Stock Exchange: http://www.nyse.com/about/listed/1111491853070.html
NYSE Big Board: http://www.nyse.com/about/listed/1218155409083.html

Philip Oettinger (650) 565-3564 poettinger@wsgr.com

Brian Curran
Managing Director, Global Corporate Client Group, New York Stock Exchange
Brian has an extensive operating background with venture-backed companies in the Bay Area, in addition to sell-side M&A advisory experience. In his current role, he is responsible for developing corporate listings and fostering relationships with corporate issuers and key constituents in the listing decision process. Brian is based in Palo Alto, California, and can be reached at (650) 461-6971 or bcurran@nyx.com.

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Promotional Practices Lead to Major Sanctions against Individuals, Corporations

By Jon Nygaard, Attorney, and David Hoffmeister, Partner (Palo Alto Office)

Clients often request specific examples of what can happen if promotional programs violate regulatory prohibitions, perhaps looking for evidence that only Big Pharma or large medical device companies are the target of federal and state enforcement actions. Several recent cases demonstrate that no one in an organization, big or small, who participates in promotional practices that violate federal law will be provided a safe harbor from prosecution, and even conviction and jail time. Prosecutors are sending a strong and clear message that the actions of all sales and marketing personnel will be scrutinized and prosecution will occur if “off-label” promotions are part of an overall business strategy.

Of course, the big players still garner the most press, illustrated by Pfizer’s agreement on September 1 to the largest drug-marketing settlement yet—$2.3 billion—to resolve criminal allegations and civil claims that it illegally marketed four drugs. In fact, the Department of Justice states in its press release that the portion of the settlement that constitutes the criminal fine—$1.2 billion—is the largest fine ever assessed against a U.S. company. Pfizer (its subsidiary Pharmacia & Upjohn, Inc., to be precise) agreed to plead guilty to a felony violation of the Federal Food, Drug, and Cosmetic Act (FDCA) for misbranding the anti-inflammatory drug Bextra, acknowledging that it marketed the drug for uses that the Food and Drug Administration (FDA) specifically declined to approve because of significant safety considerations.

On the civil side, Pfizer agreed to pay $1 billion to settle cases brought by whistleblowers under the False Claims Act. About one-third of that amount will go to state governments to compensate them for Medicaid reimbursements for four Pfizer drugs, including Bextra. The marketing acts that allegedly resulted in the false claims included:

• marketing Bextra for unapproved uses, and creating and distributing sales materials for those uses;
  
  
• distributing drug samples for unapproved uses;
  
  
• initiating, funding, and drafting articles for medical journal publication about unapproved uses;
  
  
• creating sham requests from physicians for information about unapproved uses;
  
  
• using advisory boards, consultant meetings, and other forms of remuneration for unapproved uses; and
  
  
• sponsoring continuing medical education (CME) programs that were not independent.

Pfizer also settled allegations concerning kickbacks involving several other drugs, and signed a five-year Corporate Integrity Agreement (CIA).

The False Claims Act authorizes whistleblowers to share in the settlement or fine if they initiate successful claims on behalf of the government. The six whistleblowers, some of whom were Pfizer employees, will share $102 million of the civil settlement.

The Prosecution of Regional and District Sales Managers

Before Pfizer reached its record settlement, two of its employees were prosecuted individually for their roles in the off-label promotion schemes. In March of this year, a district sales manager was convicted of obstruction of justice for instructing one of his sales representatives to alter and delete evidence of off-label promotion from his computer. That same month, his supervisor, a regional manager, pled guilty to a misdemeanor violation of the FDCA for off-label marketing of Bextra. She was sentenced to pay a fine of $75,000 and serve 24 months of probation. In July, the district manager was sentenced to six months of confinement with electronic monitoring and three years of probation. He was fined only $100, but as a result of the conviction was unable to keep his position as a sales manager with Abbott, which he had joined in 2005.

Bextra was approved in 2001 for osteoarthritis, rheumatoid arthritis, and dysmenorrhea. The U.S. Attorney’s Office began investigating Pfizer for its Bextra marketing practices in 2004. The regional manager was charged with having her 100-person staff promote the drug for acute pain, an indication the FDA specifically rejected for safety concerns. While acknowledging the illegality of her actions in her sentencing memorandum, she stated that she believed that some of them were lawful and consistent with how Pfizer wanted to promote the drug. She was aware, however, that the FDA had rejected Pfizer’s request to expand the indication to include acute pain. Bextra was withdrawn from the market in 2005 when data suggested that it triggered heart problems and serious skin reactions.

Recent FTC Action

In a completely separate action, but also one in which prosecution occurred years after the last sale of the products involved, several corporations and individuals associated with the marketing of calcium and herbal supplements were ordered by a federal court in August of this year to pay $70 million in consumer redress. The case was brought by the Federal Trade Commission (FTC), which regulates dietary supplements, in connection with the production and dissemination of two “infomercials” touting the two supplements as effective in preventing, treating, or curing diseases such as cancer, heart disease, and diabetes. Not surprisingly, the court found that such claims lacked substantiation and declared that they constituted deceptive advertising in violation of the FTC Act. The court’s order covered both corporate and individual defendants and ordered restitution in an amount calculated to deprive the defendants of any funds derived from the sale of the supplements. The order also included injunctive provisions to prevent the defendants from making similar representations about other products.

People at all levels, whether sales representatives in the field or top management in the corporate suite, who participate in systemic off-label promotion may be targeted for prosecution, not only at large corporations, but also at small companies. The penalties can be severe, extending beyond a Warning Letter from the FDA or a slap on the wrist, and possibly imperil the existence of the corporation or the livelihood of the individuals involved. Please contact David Hoffmeister, Jon Nygaard, Farah Gerdes, or Kristen Harrer in Wilson Sonsini Goodrich & Rosati’s Life Sciences/FDA and Healthcare practice with any questions involving marketing compliance matters.

Jon Nygaard (650) 849-3112 jnygaard@wsgr.com

David Hoffmeister (650) 354-4246 dhoffmeister@wsgr.com

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Life Science Venture Financings for WSGR Clients

By Elton Satusky, Partner (Palo Alto Office)

We have been living through unprecedented times over the past 12 months. There is little doubt that finding money is more difficult than it used to be. When available, raising capital can take a long time and terms have become less favorable to companies and founders than they were a year ago. In addition, many promising companies are unable to close rounds because they are burning too much cash or need to raise too much capital to break even. Also, some deals are oversized compared to historical raises because new investors are attempting to minimize or eliminate future financing risk. Finally, investors have reverted to tranching investments to control the flow of funds more closely, connecting the tranches to the achievement of value-enhancing milestones, and improving their internal rate of return.

The table below compares the number of transactions in which Wilson Sonsini Goodrich & Rosati clients participated, the aggregate amounts raised in each market segment, and the average transaction size in the first half of 2008, the second half of 2008, and the first half of 2009.

The table shows that the absolute number of deals actually has been constant over the six quarters ending June 30, 2009, but the total amount raised in the first half of 2008 compared to the first half of 2009 dropped 30 percent, and there was a corresponding drop in average amount raised per transaction. It’s also interesting to note that from the second half of 2008 to the first half of 2009, the number of Series A financings decreased at a lower rate, 18 percent, from 17 to 14 transactions.

The numbers confirm that capital has become scarce. In addition, what the numbers do not fully illustrate is the length of time that it takes to consummate a financing transaction, which has dramatically increased as constituents grapple with complex financing structures and difficult negotiations. Since the size of the rounds has decreased and the cost of capital generally has increased, it is critical that companies manage cash efficiently and execute on value-enhancing milestones to get to the next financing event or sale of the company. When it comes to the fundraising process, a well-thought-out strategic plan, strong support from a deep-pocketed syndicate, and planning for the long-term horizon are all critical to a successful fundraising strategy.

Elton Satusky (650) 565-3588 esatusky@wsgr.com

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Recent Life Sciences Transactions

Align Technology Agrees to Orthodontic Product Collaboration with Ormco Corporation
On August 17, Align Technology, a global medical device company that pioneered the invisible-orthodontics market with the introduction of the Invisalign system, and Ormco Corporation, a subsidiary of Danaher Corporation, a leading industrial company, announced that they have agreed to an exclusive collaboration over the next seven years to develop and market an orthodontic product that combines the Invisalign system with Ormco’s Insignia orthodontic brackets and arch wires system to treat the most complex cases. Wilson Sonsini Goodrich & Rosati represented Align Technology in the transaction. To read the Align Technology press release, please visit http://investor.aligntech.com/ReleaseDetail.cfm?ReleaseID=403557. 

Taiho to Buy Tsukuba Research Institute from Banyu
On August 3, Tokyo-based Taiho Pharmaceutical Co. and Banyu Pharmaceutical Co. announced that the two companies have reached an agreement through which Taiho will purchase Banyu’s Tsukuba Research Institute (TRI). Under the agreement, TRI’s ownership transferred to Taiho on August 31, 2009. Taiho, which currently operates research facilities in Saitama and Tokushima Prefectures, will conduct research and develop oncology products in Tsukuba. Wilson Sonsini Goodrich & Rosati assisted Taiho in the transaction. To read the Taiho press release, please visit http://www.taiho.co.jp/english/news/20090803.html.

Amgen to Collaborate with GlaxoSmithKline to Commercialize Denosumab
On July 27, Amgen and GlaxoSmithKline announced a collaboration in which the companies will share commercialization of Amgen’s monoclonal antibody denosumab for postmenopausal osteoporosis (PMO) in Europe, Australia, New Zealand, and Mexico once the product is approved in these countries. Amgen will commercialize the drug for PMO and oncology in the United States and Canada and for all oncology indications in Europe and specified markets. The financial terms of the partnership include an initial payment and near-term commercial milestones to Amgen totaling $120 million, as well as ongoing royalties. Wilson Sonsini Goodrich & Rosati assisted Amgen in the transaction. To read the Amgen press release, please visit http://www.amgen.com/media/media_pr_detail.jsp?releaseID=1312524.

Maxygen Announces Joint Venture with Astellas to Develop Protein Pharmaceuticals
On June 30, Redwood City, California-based biopharmaceutical company Maxygen announced that it has entered into an agreement with Astellas Pharma to establish a joint venture focused on the discovery, research, and development of multiple protein pharmaceutical programs, including Maxygen’s MAXY-4 program and other early-stage programs. As part of the arrangement, Maxygen will provide Astellas with an option to acquire all of Maxygen’s ownership interest in the joint venture within three years of its establishment. Wilson Sonsini Goodrich & Rosati assisted Maxygen in the transaction. To read the Maxygen press release, please visit http://www.maxygen.com/newsview.php?listid=320.

Clovis Oncology Secures $145 Million in Financing
On May 21, Boulder, Colorado-based Clovis Oncology, a healthcare company focused on acquiring, developing, and commercializing anti-cancer agents, announced that it has secured $145 million in start-up financing. The company was founded by former executives of Pharmion Corporation, which was acquired by Celgene Corporation in 2008. Domain Associates and New Enterprise Associates, both Pharmion backers, co-led the financing, which was the largest financing for a healthcare company since Xanodyne Pharmaceuticals raised $170 million in 2005, according to VentureSource. Also participating in the funding were Pharmion investors Aberdare Ventures, Abingworth Management, ProQuest Investments, and Versant Ventures, along with Frazier Healthcare Ventures. Wilson Sonsini Goodrich & Rosati assisted the investors in the financing. To read the Clovis Oncology press release, please visit http://www.domainvc.com/%5CPDF%5CClovis%20Oncology%20Raises%20Capital.pdf.

Roche Completes Acquisition of Genentech
On March 26, Basel, Switzerland-based Roche and South San Francisco-based Genentech announced that Roche has completed its acquisition of Genentech pursuant to a short-form merger in which Genentech became a wholly owned member of Roche. Earlier in the month, the two companies announced that they had signed a merger agreement under which Roche would acquire the outstanding publicly held interest in Genentech for $95.00 per share in cash, or a total payment of approximately $46.8 billion to other equity holders of Genentech. Wilson Sonsini Goodrich & Rosati advised Genentech in the transaction. To read the Genentech press release, please visit http://www.gene.com/gene/news/press-releases/display.do?method=detail&id=12007.

NovaBay and Galderma Enter Agreement to Develop and Commercialize Aganocide Drugs
On March 25, Emeryville, California-based NovaBay Pharmaceuticals announced that it has entered into an agreement with Galderma, a pharmaceutical company devoted exclusively to the dermatological field, to develop and commercialize NovaBay’s proprietary Aganocide compounds. The exclusive agreement is worldwide in scope, with the exception of certain Asian markets, and covers all major dermatological conditions. Under the terms of the deal, NovaBay expects to receive up to $50 million upon the achievement of certain development and regulatory milestones and future royalties on net sales of products. Wilson Sonsini Goodrich & Rosati represented NovaBay in the transaction. To read the NovaBay press release, please visit http://www.novabaypharma.com/investors/press/mar_25_2009.html.

Navigenics Acquires Clinical Testing Facility
On March 19, Navigenics, a personal genomics testing company based in Foster City, California, announced its acquisition of the Affymetrix Clinical Services Laboratory, a CLIA-certified testing facility based in West Sacramento. With the purchase of the testing facility, Navigenics will be able to offer fully integrated DNA scanning and analysis services. Wilson Sonsini Goodrich & Rosati represented Navigenics in the acquisition. To
read the Navigenics press release, please visit http://www.navigenics.com/visitor/about_us/press/releases/lab_acquisition_031909/.

Bausch & Lomb, Santen Strike Licensing Agreement for Intraocular Lens Development
On March 3, Aliso Viejo, California-based Bausch & Lomb, the global eye-health company, announced that it has entered into a licensing agreement with Santen Pharmaceutical Co. for the development of certain intraocular lens (IOL) materials. Under the terms of the agreement, Bausch & Lomb has obtained the rights to Santen’s hydrophobic acrylic polymers, from which it may commercialize new IOLs for sale worldwide. The financial terms of the agreement were not disclosed. Wilson Sonsini Goodrich & Rosati represented Bausch & Lomb in the transaction. To read the Bausch & Lomb press release, please visit http://www.bausch.com/en_US/corporate/corpcomm/news/Santan.aspx.

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Life Sciences Events

Phoenix 2009: The Medical Device & Diagnostic Conference for CEOs
October 1 - 4, 2009
Four Seasons Hotel
Las Vegas, Nevada
www.wsgr.com/news/phoenix

Phoenix 2009 will mark the 16th annual conference for chief executive officers and senior leadership of medical device and diagnostic companies. The event will provide an opportunity for top-level executives from large healthcare and small venture-backed companies to discuss strategic alliances, financing, and other industry issues.

Wilson Sonsini Goodrich & Rosati’s Biotech Board of Directors Dinner
January 13, 2010
Sir Francis Drake Hotel
San Francisco, California

Wilson Sonsini Goodrich & Rosati’s eighth annual Biotech Board of Directors Dinner, geared toward executives and directors of biotech companies, is an exclusive dinner and networking event that will focus on key industry issues.

Wilson Sonsini Goodrich & Rosati’s Medical Device Conference
June 2010
The Fairmont
San Jose, California
www.wsgr.com/news/medicaldevice

Wilson Sonsini Goodrich & Rosati’s 18th annual Medical Device Conference, aimed at professionals in the medical device industry, will feature a series of panels and discussions addressing the critical business issues facing the industry today.

Casey McGlynn, a leader of the firm's life sciences practice, has editorial oversight of The Life Sciences Report and was assisted by Elton Satusky and Scott Murano. They would like to take this opportunity to thank all of the contributors to the Report, which is published on a semi-annual basis. Casey McGlynn (650) 354-4115 cmcglynn@wsgr.com Elton Satusky (650) 565-3588 esatusky@wsgr.com Scott Murano (650) 849-3316 smurano@wsgr.com

Click here for a printable version of The Life Sciences Report

This communication is provided for your information only and is not intended to
constitute professional advice as to any particular situation.

© 2009 Wilson Sonsini Goodrich & Rosati, Professional Corporation