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2017-01-29 08:55:09
Fair Game: A Costly Drug, Mising a Dose of Disclosure

Full and fair disclosure is at the heart of our nation’s securities laws. So red flags fly when a company is silent on facts of interest to investors.

That investing truth came to mind a little over a week ago, when the pharmaceutical giant Mallinckrodt Pharmaceuticals settled a yearslong investigation by the Federal Trade Commission. In the Jan. 18 complaint, the commission contended that Mallinckrodt and its Questcor subsidiary had engaged in anti-competitive behavior by acquiring the rival drug to their costly H. P. Acthar Gel — which goes for $38,000 a vial — and keeping it off the market to protect their profits.

Mallinckrodt disputed the F.T.C.’s conclusions but agreed to pay $100 million. It must also license the rights to the rival drug, known as Synacthen Depot, to a competitor for two indications. Synacthen is sold overseas for a tiny fraction of the price of Acthar (which has topped a list of the most expensive drugs covered by Medicare).

Both medications address a range of severe autoimmune conditions, such as spasms in infants and nephrotic syndrome, a kidney disorder.

Mallinckrodt said the settlement would not have an impact on its net sales. And a cheering section of Wall Street analysts agreed that the F.T.C. deal was a nonevent — and reiterated the buy recommendations on Mallinckrodt shares.

And yet, there is something troubling for Mallinckrodt shareholders in the antitrust settlement: Its facts underscore a disclosure lapse by the company during the summer of 2014 related to the F.T.C. inquiry. On June 11, 2014, Questcor had received a subpoena from the F.T.C., which was investigating it for anti-competitive activities. But investors didn’t learn about the subpoena until months later.

Why is a 2014 disclosure issue relevant now? Two reasons. First, it occurred in the middle of Mallinckrodt’s $5.6 billion bid for Questcor. The existence of a subpoena to Questcor would seem to have been of interest to Mallinckrodt’s shareholders as they mulled whether to approve the purchase of what was a one-drug company.

More broadly, the incident revealed a minimalist’s approach to disclosure at Mallinckrodt. This is worth knowing, given that United States Attorneys in two different districts are investigating Questcor’s marketing practices.

Let’s return to the events of 2014. That April, Mallinckrodt announced its bid for Questcor, a company with $800 million in revenues that came almost entirely from sales of Acthar, a 60-year-old, off-patent drug.

Questcor had bought the rights to Acthar for $100,000 in 2001 and soon began raising the price from $40 a vial.

In June 2013, when Acthar cost $28,000 a vial, Questcor paid $135 million to Novartis to purchase the rights to Synacthen, a synthetic, vastly cheaper competitor drug prescribed in Canada and Europe. Although Questcor said it would develop Synacthen for conditions where it “would potentially provide a clinical benefit over Acthar,” it did not follow through on that pledge. Synacthen stayed on the shelf, and Acthar’s price kept rising.

Less than a year later, Mallinckrodt came knocking for Questcor, offering its shareholders a 27 percent premium to the prevailing stock price before the merger announcement.

Over the next few months, as Mallinckrodt shareholders weighed whether to approve the deal, they received company filings that detailed the risks in the acquisition. Nowhere did the F.T.C. subpoena come up — it was the proverbial dog that did not bark.

Mallinckrodt shareholders approved the deal in August 2014. But it wasn’t until November that they learned about the subpoena Questcor had received from the F.T.C. in June 2014. In a Mallinckrodt 10-K filing, they were told that the F.T.C. sought materials and information from Questcor about whether its acquisition “of certain rights to develop, market, manufacture, distribute, sell and commercialize Synacthen Depot from Novartis violates the antitrust laws.”

About a week after this disclosure appeared, Matthew K. Harbaugh, Mallinckrodt’s chief financial officer, told participants at a Piper Jaffray Healthcare Conference that the company had included the information about the F.T.C. subpoena in the 10-K “just to make sure that it is fully transparent to investors.”

We now know that the F.T.C. concluded that Questcor, and subsequently Mallinckrodt, engaged in anti-competitive conduct.

Investors, especially those considering a corporate merger, expect a company to disclose meaningful information that could change their views on the deal. Central to such disclosures is the concept of materiality; if a company fails to disclose material information, it could run afoul of the securities laws. Companies must make determinations on materiality regularly, and people can disagree on these assessments.

So this raises a question for Mallinckrodt shareholders: Should their company have told them about the subpoena as they considered approving the Questcor deal?

“In my opinion, yes,” said Lewis D. Lowenfels, an authority on securities law and an adjunct professor at Seton Hall University Law School. “There are two tests for materiality in disclosure: whether there is a substantial likelihood that a reasonable shareholder would have considered the information important in deciding how to vote, and/or whether a reasonable investor would have viewed the undisclosed information as having significantly altered the total mix of information made available.”

“Under either test,” he added, “I think the existence of an F.T.C. subpoena within the factual context of this merger is material.”

A spokesman for Mallinckrodt, Daniel Yunger, said it had “complied with all legal and regulatory requirements in all public disclosure decisions related to the F.T.C. matter.”

Further, he said that the company “continues to strongly disagree with allegations outlined in the F.T.C.’s complaint, believing that key claims are unsupported and even contradicted by scientific data and market facts.”

Remarkably, the decision to stay mum about the F.T.C. subpoena came even as Mallinckrodt and Questcor were responding to concerns expressed by the Securities and Exchange Commission about inadequate risk disclosures in their merger documents.

For example, federal filings contain S.E.C. letters to Mallinckrodt and Questcor on June 19, 2014, asking for additional disclosures. One area of interest to the S.E.C. was what the companies told investors about the risks of lower reimbursements on Acthar by private insurers because of its high cost. The S.E.C. also asked the companies to provide more information about adverse medical reactions among Acthar patients, such as deaths or disabilities, that had been detailed a few days earlier in an article in The New York Times.

“We urge all persons who are responsible for the accuracy and adequacy of the disclosure in the filing to be certain that the filing includes the information the Securities Act of 1933 and all applicable Securities Act rules require,” the S.E.C. told the companies.

Both Questcor and Mallinckrodt responded to the S.E.C. by expanding their disclosures. But because the S.E.C. does not post this correspondence on its website until months after it is written, investors did not learn about the regulator’s concerns until Feb. 2015.

It is probably fair to say that investors will always prefer more robust disclosures from companies than management wants to give. Still, it’s good to know when a company seems to believe that “less is more” where disclosure is concerned. That way, at least, investors can steel themselves for unpleasant surprises.