Editor

Last week, on the day Cel-Sci Corp. told the world about positive data from the long-term follow-up study with its lead cancer drug Multikine, CEO Geert Kersten remarked: "I’m living the American nightmare."

But Kersten wasn’t talking about Multikine, a mixture of cytokines, including interleukins, interferons, chemokines and colony-stimulating factors that increased survival of head and neck cancer patients in the Phase II trial, as shown in data published in the May 2005 edition of the Journal of Clinical Oncology.

Enrolled in the study were people with advanced primary disease who were scheduled for their first treatment. They were given Multikine for three weeks before surgery or surgery plus radiation and chemotherapy. In the follow-up, the median period was 3.2 years. Detailed results will be published later in a journal, but Kersten said survival and two-year local regional control of the disease beat the rates that have been reported in scientific literature from 39 trials between 1987 and 2004.

Multikine isn’t the problem. Something called "EITF 00-19" - and the SEC’s new seriousness about it - is the problem.

The acronym stands for the Emerging Issues Task Force, set up by the Financial Accounting Standards Board, and the number refers to guidance entitled "Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock."

EITF 00-19 has been floating around since 2000, noted Stephen Drake, partner in the corporate and securities practice (with a focus on healthcare and life sciences) of Epstein, Becker & Green P.C., "but the accounting industry, for whatever reason, never really adopted the guidance or chose to ignore it." Now, accountants and the companies they work for, such as Cel-Sci, are finding themselves in some trouble.

"This standard particularly impacts issuers of convertible securities where the conversion price does not have a floor," Drake wrote in a recent alert, circulated to clients. "As such, small public companies that do PIPE transactions are among the most vulnerable to this issue."

Kersten said Cel-Sci, which reported in January that it was unable to file its 10-K with the SEC on time because of auditors’ questions about financings between 2001 and 2003, is positioned as "the lucky vanguard" of firms taking on the difficulties brought by the SEC’s attention to EITF 00-19.

Earlier this month, Cel-Sci offered preliminary financial results for the quarter ending Dec. 31, 2005 - preliminary because the firm is working on the restatement of prior years’ financials, thanks to EITF 00-19. A few days later, to keep its stock listed, the company submitted a plan to AMEX under which Cel-Sci would file its late 10-K by March 20.

"Whatever people think [the guidance is about], it’s 10 times worse," Kersten said.

Specifically, EITF 00-19 requires companies to classify convertible equity instruments such as notes, warrants and preferred stock as liabilities in cases where the issuer’s ability to "net share settle" - that is, pay off - the instrument in equity is not entirely within the firm’s control.

For example, Drake said, if the formula for conversion is tied to the market price of the stock, "the company may not be able to say with certainty that they’ll have enough stock to cover it," a factor often covered in risk statements.

Under the guidance, "you’d have to take that financial instrument you’ve booked as equity and move it to the liability portion of your balance sheet. You thought you raised money and you find out you issued debt. You could literally go from having a positive balance sheet to having an upside down balance sheet - from showing a profit according to GAAP to showing a loss according to GAAP."

The consequences won’t be so dire for Cel-Sci, but EITF 00-19 created plenty of headaches, Kersten said.

"I have an MBA in finance and a law degree, and I think I’m fairly educated," he said. "Now I understand [the guidance], but that’s only for working on it two months straight. This is going to be hitting others, and they don’t have a clue."

The guidance, enforcement of which also would do away with assessing "liquidated damages" to issuers who don’t properly get their PIPEs registered, already is making itself somewhat known in other industries. BIO-key International Inc., which develops finger-based biometric identification and wireless public safety systems, said in late January that the SEC, after examining the registration statement related to the June 2005 financing, "raised questions with regard to our convertible term notes, suggesting that we consider EITF 00-19."

Regulators had other questions as well, and BIO-key ended up changing its financial statements for 2003 and 2004 as well as six quarters in 2004 and 2005, though the move likely would "not have any effect on the company’s cash balance for these periods or have any negative impact on cash and income in future periods," BIO-key said.

Maybe that’s all the guidance will turn out to mean in the biotech space as well - "a hassle," Drake said, though the chance of bumping against EITF 00-19 is somewhat greater in the life sciences, "where the length of time to get from commencement of business to revenues is so long. Because the investment is riskier and it’s a longer term play, it’s a little more likely that a hedge fund or other investor will insist on a floorless conversion mechanism."

Among investors in the smaller companies, he said, "it very well could be that nobody cares [about restatements]. The balance sheet is already upside down, and the stock is priced to take account of the fact that their drug has a 1 in 5,000 chance of being approved. It’s too early to tell but it will be interesting to see how sophisticated Wall Street will be in looking at these statements."

Shareholder lawsuits "are always possible," he said, in "a case where a company was failing anyway, but didn’t look as bad a year ago, when Mr. and Mrs. X bought the stock. They may have a cause of action now, if they can demonstrate they would not have bought the stock had they known."

But in many cases, the firms might end up with nothing more onerous than the cost and delay of redoing the books, Drake said, using the example of a hypothetical company that has completed a $5 million floorless convertible PIPE offering.

"They can say [to investors], ‘We still have the $5 million. We thought we accounted for it properly, but the cash is there, either way,’" he said.

Kersten, though, was not optimistic about EITF 00-19’s ultimate effect, saying he’d heard through the grapevine of a company that "did a $10 million deal, and they will be taking a $26 million charge. This is going to totally change the way financing is done."

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