How the FDA Brought Its Insider-Trading Scandal On Itself

The civil and criminal charges filed against Cheng Yi Liang, a chemist at the FDA who allegedly used his inside knowledge of upcoming new drug approvals to trade stock in 27 pharmaceutical companies, appears to be a case of dumb meets dumber.

What's dumb is the FDA's system for announcing new drug approval decisions: It has a built-in, secret time window that begs insiders at the agency and the companies involved to buy and sell stock after the FDA reveals its decision to the company but before an official announcement is made 24 hours later.

Dumber still is Liang, who continued to access the FDA's computer system to track drug approvals even though every time he did so the system warned him that he was being monitored and that he may face criminal penalties for misusing the data, according to an FBI affidavit in the case.
It's common knowledge in the drug business -- but, crucially, not outside the drug business -- that the FDA deliberately creates the most valuable insider information possible and then tempts its own staff and executives at companies involved to trade on it. The SEC's civil complaint describes it this way:

The CDER's [FDA Center for Drug Evaluation and Research] practice is to issue a press release 24 hours after it has notified the sponsor that its drug has been approved. The sponsor, however, may disclose earlier that it has submitted a new drug application, received a complete response letter, or received approval for its drug.

In other words, the FDA makes its decision and secretly tells the company. At which point everyone at the FDA and the company has to sit on their hands for 24 hours, pretending that nothing has happened. You could probably gain inside information on whether a new drug is approved or not simply by sitting in the parking lot of a small drug company and checking to see whether the CEO leaves work with a smile on his face or not.

Clearly, this is a flaw in the system. There is no important need for companies to get a brief advance on whether their drugs get a green light. It would be more practical for the FDA to make its decisions transparently, in public, and inform everybody at the same time.

Liang, having been tempted by this loophole, somehow managed to ignore repeated warnings that his activity was being monitored. On Jan. 6, 2011, the Office of the Inspector General installed screenshot software on Liang's computer to monitor what he was looking at. It's not clear whether Liang knew about that, but he must have known something because every time an FDA employee logs into the agency's system they get this unsubtle disclaimer, according to the affidavit:

WARNING -- WARNING -- WARNING -- WARNING -- WARNING
You have no reasonable expectation of privacy regarding any communications or data transiting or stored on this information system. At any time, and for any lawful government purpose, the government may monitor, intercept, and search and seize any communication or data transiting or stored on this information system.

Liang is accused of gaining $3.7 million from trades in small companies whose stock price could move based on a single new drug decision. Here's a cute chart showing how he allegedly made out.

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