In a year fraught with scandal, legislative scrutiny brought on by apparent ledger-sheet (and other) misdeeds by the likes of Enron Corp. and ImClone Systems Inc. has meant a tighter, more supervised environment all around.
But at least one area shows signs of loosening up, and to the benefit of biotechnology - especially smaller, fledgling firms that need it most.
In the crosshairs is the Investment Company Act (ICA) of 1940, the original aim of which was to keep so-called start-ups from raising cash and then using it for investment purposes instead of getting a true business under way. The ICA goes about blocking such moves by defining "investment company" very specifically - so specifically that it has pigeonholed legitimate biotechnology firms in a category where they don't belong.
As things stand, it's almost inevitable. Research and development firms often have few tangible assets but plenty of capital in readily available funds, which they often use to enter strategic alliances that include buying noncontrolling securities in another R&D firm. Once a biotechnology company ends up in the "investment company" box, its operations are limited by the ICA's rules.
ICA defines an investment company as including any issuer that owns or proposes to acquire investment securities with a value of more than 40 percent of the issuer's total assets, excluding government securities and "cash items" on an unconsolidated basis.
By investment securities, ICA means all securities other than government securities and those issued by majority-owned subsidiaries that are not investment companies. Value of assets that are not securities means "fair value at the end of the last preceding fiscal quarter, as determined in good faith by the board of directors."
A proposed change in the law would let the SEC provide a "non-exclusive safe harbor" from the definition of investment company for some R&D firms, including those in biotechnology.
"If you go over the 40 percent, you're presumptively in the investment company category, and this rule would allow you to get out," explained Matthew Chambers, attorney with Wilmer, Cutler & Pickering in Washington, which is representing the concerns of the Washington-based Biotechnology Industry Organization in the ICA matter.
As recently as the autumn of 2000, when the Securities and Exchange Commission was celebrating ICA's 60th anniversary, Paul Roye, director of the SEC's investment-management division, called the rule "remarkably resilient," and said those who put it together "understood that markets and circumstances change, and that industries evolve."
But maybe they didn't foresee everything. While few would argue the ICA has failed in what President Franklin D. Roosevelt saw as its primary goal of diversifying risk for small investors, such as those who put money in mutual funds, the law has made life hard for R&D biotechnology firms.
The small ones are most restricted. Chambers noted there are other stipulations than the 40 percent rule "that can get you out [of the investment category] if you use certain income and asset tests," and those stipulations let bigger, already-profitable biotechnology firms and pharmaceutical companies avoid falling into it.
In 1993, the SEC issued a ruling on a case involving ICOS Corp., of Bothell, Wash., exempting the company, which had little income from non-investment sources and wanted to boost its investments even more.
The commission allowed that it would consider a firm in the "non-investing" category if the company generally spent more on R&D than it earned in gross investment income, although the latter could occasionally outstrip the former. A substantial portion of gross expenses had to go toward R&D, too, and investment expenses had to be negligible. Also, just about all of its investments had to be secure, rather than involving equity or speculative debt.
But the SEC and others believe the time has come for a more definite and comprehensive change in the rule.
As it stands, the ICA measures the amount of strategic investment by total assets, whereas the proposed change would measure it by an R&D budget - only fair, Chambers told BioWorld Today, since that's the way to prove the firm is an R&D company.
The change would give R&D companies more leeway to raise and invest capital pending its use in R&D and other operations, and would clarify the extent to which a company relying on it is allowed make investments in other R&D firms as part of collaborative programs.
Under the guidelines of the SEC's propose change, a company would qualify to escape that definition if it meets four criteria.
First, the company would have R&D costs that represent a "substantial percentage" of total expenses for the last four fiscal quarters combined, and that equal at least half of its investment revenues for the same period.
Second, the company would have investment-related expenses not more than 5 percent of total expenses for the period.
Third, it makes investments for the purpose of conserving capital and liquidity until it uses the funds in its main business. This criterion is subject to certain exceptions.
Fourth, the company is "mainly engaged" in non-investment work.
Smaller firms are not the only ones to benefit, Chambers said. Medium-sized companies with no profit or significant sales would be helped as well. "[The change] gives them more certainty about their status," he said.
And even the biotechnology heavyweights have an interest. Cambridge, Mass.-based Millennium Pharmaceuticals Inc. is known to be taking an out-front position in favor of the change, although the company referred phone calls to Chambers.
"They're certainly not profitable yet," he said. "And companies go in and out of profitability."
Peter Norman, manager of federal government relations for BIO, said whether the change will go through as planned or with revisions is "really hard to tell" - but for once the proposal as it stands is not unsatisfactory, and BIO "likes this rule overall," Norman said.
"Obviously, we applaud the SEC because of the positive impact this is going to have and we support the proposal, but we plan to request a higher ceiling," he said.
Specifically, under the proposed change, biotechnology firms could invest up to 10 percent of their total assets and up to 20 percent of liquid assets, he said. In the latter category, BIO will ask for the limit raised to be between 25 percent and 30 percent.
The SEC is taking comments on the proposal until Jan. 15, and a decision is expected in the spring.