SEC Scrutiny of Pharma and Life Sciences Companies: Investigation Focus Areas

The life sciences industry, including pharmaceutical, biotechnology, and medical device companies, operates in a complex regulatory environment. Companies in this space are subject to oversight from agencies like the FDA and CMS that regulate product development, marketing, and reimbursement. At the same time, being publicly-traded makes these companies subject to securities laws enforced by the SEC.

Over the past few years, SEC scrutiny of life sciences companies has intensified. The SEC has focused enforcement efforts on areas where the interests of federal health regulators and securities regulators overlap. Increased SEC attention means life sciences companies face heightened risks related to disclosures, insider trading, and financial reporting.

Disclosure Issues

One major area of focus for the SEC is the accuracy and completeness of disclosures made by life sciences companies. Specifically, the SEC looks at disclosures related to:

• Clinical trial results
• Regulatory communications
• Product safety
• Government investigations

If the SEC believes a company intentionally misled investors in any of these areas, it can bring an enforcement action for securities fraud. For example, in 2018 the SEC charged Theranos and its CEO with raising over $700 million from investors using false claims about its blood testing technology. The SEC said Theranos made “numerous false and misleading statements in investor presentations, product demonstrations, and media articles” for years.

To avoid issues, life sciences companies need robust disclosure controls and procedures. They should vet disclosures internally and with outside counsel to confirm they are complete, accurate, and provide appropriate context.

Insider Trading

Another major SEC focus area for life sciences companies is insider trading. The SEC routinely investigates when investors connected to life sciences companies trade stock around significant events like clinical trial results or regulatory decisions. These events often move stock prices and present opportunities for illegal insider trading.

For example, in 2020 the SEC charged a biotech executive and two others with insider trading ahead of negative clinical trial results. The SEC said the executive provided nonpublic information to the other two individuals who then sold stock in the company before the failed trial was announced.

To limit insider trading issues, life sciences companies should have policies restricting trading around key events. They may also consider setting regular blackout periods where insiders cannot trade stock at all. Robust monitoring of trading patterns can also help identify potential issues early.

Accounting and Financial Reporting

Questions related to accounting and financial reporting have also led to increased SEC scrutiny of life sciences companies. Common issues include:

• Improper revenue recognition
• Inaccurate disclosures around pricing and drug channel relationships
• Misstating R&D costs
• Understating liabilities and expenses

For example, in 2020 the SEC charged a pharmaceutical company with accounting fraud for misstating billions in revenue from its largest drug. The SEC said the company used sham transactions to hide declining demand and improperly recognize revenue.

To avoid problems, life sciences companies need strong internal controls over financial reporting. Additional SEC scrutiny means external auditors are also paying closer attention to areas like revenue recognition and expense classification.

Relationships with Intermediaries

In addition to the areas above, the SEC is closely examining relationships between life sciences companies and intermediaries like pharmacies, PBMs, and group purchasing organizations (GPOs). The SEC is focused on whether side arrangements like rebates, discounts, and service fees may improperly influence purchasing decisions.

For example, the SEC charged a pharmaceutical company in 2020 with using a web of charitable donations, free goods, and excess payments to induce pharmacies to recommend its drugs. The SEC said these arrangements resulted in false and misleading statements that hid the true source of company revenue growth.

To limit risks, life sciences companies should ensure they have proper controls around interactions with intermediaries. They need to accurately disclose the nature of relationships and how they impact the business.

DOJ and FDA Parallel Investigations

When investigating life sciences companies, the SEC often collaborates with other regulators like the DOJ and FDA. Alleged violations of FDA regulations frequently trigger parallel SEC investigations into whether investors were properly informed.

In these cases, the FDA focuses on regulatory violations and product safety issues. Meanwhile, the SEC focuses on whether disclosures to investors around the issues were complete, accurate, and timely.

For example, the SEC and DOJ jointly investigated claims that a medical device maker concealed widespread failures of one of its key products. The agencies alleged the company made false claims about the device’s safety and effectiveness, leading to inflated stock prices.

Life sciences companies need to be aware of this interplay between FDA rules and SEC disclosure requirements. Any FDA violations require carefully evaluating whether investors need to be informed as well.

Congressional and Shareholder Interest

Beyond SEC and DOJ enforcement, life sciences companies also face scrutiny from Congress and shareholders. Congressional committees frequently investigate drug pricing issues and allegations of anticompetitive behavior. These inquiries can trigger SEC investigations if it appears companies did not make accurate disclosures.

Shareholder lawsuits are also common following regulatory enforcement actions, product safety issues, or disappointing clinical results. Shareholders will claim companies and executives misled them about material facts impacting the business.

While not direct SEC actions, congressional and shareholder scrutiny often runs in parallel with SEC investigations. Life sciences companies need to navigate all these areas carefully to avoid making false or misleading statements.

Best Practices for Life Sciences Companies

Given the high-risk environment, life sciences companies should take steps to mitigate regulatory and enforcement risks. Best practices include:

• Maintain robust disclosure controls and vet all public statements thoroughly
• Restrict trading around key events and monitor for suspicious activity
• Ensure accounting and financial reporting comply with all rules and standards
• Document relationships with intermediaries and disclose appropriately
• Assess implications of FDA violations for investor disclosures
• Engage proactively with Congress and shareholders to avoid misinformation

With regulators, Congress, shareholders, and plaintiffs attorneys all scrutinizing their actions, life sciences companies need to be thoughtful and disciplined. Careful compliance and transparency is essential to avoiding costly regulatory and legal issues.