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Guess Who's (Mostly) Not to Blame for Insider Trading in Pharma Stock?

A recent insider trading case regarding executives at Sequenom (SQNM) might have given you the impression that illegal stock trades in the drug business occur when folks inside a company realize big news is coming up and leak it to their friends ahead of time. But the feds' recent sweep of insider traders in the healthcare business -- uncovering unfair trades related to the stock of Pfizer (PFE), Merck (MRK), AstraZeneca (AZN), Takeda, Endo and Indevus (IDEV), among others -- shows that it is investment banks and hedge funds that drive most insider trading in healthcare, not executives inside pharmaceutical companies.

Insider trading isn't unique to the pharma sector but the industry is more vulnerable to it: clinical trial results and FDA decisions create sudden turning points for company stock that don't exist in, say, the soda pop or beer businesses.

Most companies have policies banning their executives from trading stock or helping others do that on their insider knowledge. (Also, it's illegal.) Nonetheless, the temptation is often too much, especially when executives learn that disaster is about to befall their employer, jeopardizing their personal holdings (that's what happened in the Martha Stewart-ImClone case); or that the company is about to announce a big success, creating a fortune for anyone lucky enough to buy the stock ahead of time. Those two scenarios appear to have been the motivations behind alleged insider trades at Sequenom and, 13 years ago, at Cephalon (CEPH), where seven people were charged with buying ahead of favorable trial results.

But corporate ethics policies have mostly worked in preventing employees from trading their own stock, if the FBI's recent investigation is any guide. That probe is centering on the investment banks that advise drug companies during their mergers. When one company buys another, the stock of the acquired company usually goes up and the buying company goes down, creating the opportunity for dubiously lucky trades.

Igor Poteroba, an investment banker at UBS pled guilty today to doing just that on Takeda's acquisition of Millenium and Endo's buyout of Indevus, along with a bunch of smaller deals. Poteroba sent lamely coded emails to his coconspirator advising him of timely buys, such as:

Keep me posted as to how many frequent flier miles you've got this far and how many you plan to get by Friday
(Not-very-well-coded signals are a bit of a trend on Wall Street, it appears.) They netted $870,000 in illegal gains.

Earlier in the month, authorities looked at the following deals, per the Wall Street Journal:

MedImmune shares jumped 18% on April 23, 2007, the day the deal (with AZ) was announced. Trading was heavy before the announcement, driving shares up more than 50% over six weeks.

Wyeth shares rose 12% when news broke in January 2009 that it was being acquired by Pfizer. Wyeth had gained more than 20% in six weeks.

Schering's shares rose 14% on March 9, 2009, the day its acquisition by Merck was announced. On the Friday before the weekend going into the deal, the shares had risen 8%, much of that in late-day trading.

Goldman Sachs advised Schering and Medimmune; Morgan Stanley and Evercore Partners advised Wyeth. SAC Capital Advisors, Diamondback Capital Management, Jana Partners, and Balyasny Asset Management all increased their holdings prior to the transactions.

It's tough to see what drug companies could do to prevent executives at the banks that advise them from doing dirty deals. One possible solution: Insert a penalty clause into a bank's M&A advice contract that would trigger a cash payment to the drug company if insider charges are brought against any of its employees. (Don't hold your breath waiting for that, though.)

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