Spurred by reports of biopharma executives exercising stock options in conjunction with announcements about COVID-19 vaccine developments and government contracts, U.S. lawmakers want to close the loopholes that make such actions legal.

Many companies affected by the pandemic are having sudden increases and decreases in their stock valuation, Rep. Brad Sherman (D-Calif.) said Sept. 17 in opening a House Financial Services subcommittee hearing on insider trading and stock option grants involving executives of companies developing COVID-19 vaccines and therapies. He noted that, with biopharma, even the suggestion of a federal grant can cause a company’s stock to shoot up in value.

For instance, Moderna Inc., Novavax Inc. and the Eastman Kodak Co. each saw their value rise more than 400% following news of government grants for vaccine development or, in the case of Kodak, a $765 million government loan to launch a pharmaceuticals division, Sherman said.

Jill Fisch, co-director of the Institute of Law and Economics at the University of Pennsylvania Law School, testified about the historic market swings during the pandemic. “In the past six months, capital markets have experienced unprecedented levels of volatility and trading activity,” she said.

The incredible price swings in biopharma and other areas have encouraged insider trading and over-optimistic announcements that drive up stock prices, she said. At the same time, “issuers are in a challenging environment,” she added. “They’re pressured to disclose as much information as possible.” But in hindsight, some of that information may prove too optimistic.

When it comes to developing COVID-19 vaccines and therapies, companies are taking baby steps, not knowing if those steps will pan out, Fisch said. And in the current environment, they’re not sure what should be disclosed.

Granville Martin, senior vice president and general counsel for the Society for Corporate Governance, agreed. He said a lot of companies are trying to figure out how to assess the “materiality” of information that wouldn’t have met disclosure requirements prior to the pandemic.

The SEC’s guidance on the matter has been to encourage companies to practice “good corporate hygiene” during the pandemic, Sherman said, but such “admonishments will not deter the truly greedy.” Thus, it’s up to Congress to change the law to protect investors from those who aren’t deterred by admonishments, he told his colleagues.

The House already has passed three bills to close insider trading loopholes:

  • The Promoting Transparent Standards for Corporate Insiders Act, H.R. 624, would require the SEC to study and report on possible revisions to regulations regarding Rule 10b5-1 trading plans, which create a safe trading harbor for certain employees;
  • The Insider Trading Prohibition Act, H.R. 2534, would prohibit certain securities trading and related communications by those who possess material, nonpublic information;
  • The 8-K Trading Gap Act, H.R. 4335, would direct the SEC to issue a rule requiring public companies to have policies and procedures prohibiting officers and directors from trading company stock in the time between a significant corporate event and the filing of the Form 8-K disclosing the event.

An ‘unclean heart’

In addition, Sherman is proposing a bill to address “spring-loading options” – stock options offered to executives shortly before a major public announcement. The options are approved by shareholders, who know nothing of the announcement, based on fair market value, which reflects the closing price of that day. However, the board knows that the value is likely to increase significantly the next day or the next week because of a scheduled announcement. That means the shareholders are being duped, Sherman said.

While spring-loading isn’t necessarily illegal, it involves “an unclean heart,” Jacob Frenkel, chair of government investigations and securities enforcement at Dickinson Wright, told the subcommittee.

“This is legal until we make it illegal,” Sherman said. His bill would restrict issuers from granting stock options if the issuer has material nonpublic information.

The hearing was driven by the timing and grant of stock options at Moderna, Novavax and Kodak. A memo from the Democratic staff of the committee cited the three companies as examples of possible “corporate profiteering” from the pandemic.

The memo noted that Novavax was awarded $1.6 billion through the government’s Operation Warp Speed COVID-19 vaccine program, even though the Gaithersburg, Md.-based company hasn’t brought a single vaccine to market in its 33-year history. The company’s stock (NASDAQ:NVAX), which had been trading at less than $4 per share at the start of the year, soared to nearly $190 per share by August.

“As of late July, Novavax’s CEO, Stanley Erck, and three other Novavax executives stood to earn options that were reportedly worth $101 million,” according to the memo. It also noted that Novavax insiders, in August, sold 172,979 company shares worth nearly $17 million.

In the case of Moderna, after the company stock (NASDAQ:MRNA) increased more than 24% on the news that the Cambridge, Mass., company was making progress toward a COVID-19 vaccine, certain executives reportedly altered their 10b5-1 trading plans to increase the number of company stocks they could sell, according to the memo. Moderna’s CEO sold 72,000 company shares for a $4.8 million profit, and its president altered his trading plan to allow him to sell $1.9 million in company shares.

In responding to lawmaker questions, Fisch pointed out that the Moderna trades were made after the information was made public so they were not insider trading. However, she said, they raise the question of whether companies getting so much government funding should be compensating executives as much as they are.

Moderna has received nearly $1 billion in government funding to develop and scale up the vaccine. Then last month, the government bought 100 million doses of its mRNA-1273 vaccine with a new award worth up to $1.525 billion.

The memo also questioned Kodak stock (NYSE:KODK) sales around the July 28 announcement that the U.S. International Development Finance Corporation (DFC) would sign a letter of intent to loan $765 million to Kodak, of Rochester, N.Y., for a new company that would produce critical active pharmaceutical ingredients. More than a month before the letter was announced, Kodak’s CEO bought 46,737 of Kodak stock and a board member purchased 5,000 shares. Those shares increased in value by more than 1,000% after the letter was announced, and the CEO’s shares yielded a reported $1.5 million profit, the memo said.

In addition, the day before the letter was announced, Kodak’s board reportedly issued the CEO $1.75 million stock options, allowing him to purchase the shares “at prices ranging from $3.03 to $12,” according to the memo. Although the company’s share prices eventually declined amid allegations of insider trading and the DFC putting its loan on hold, the options could have been worth $50 million in late July.

Following a narrow investigation, independent counsel said the trades were legal, but the SEC is conducting a much broader investigation, Frenkel said at the hearing. He added that the investigation could go on for nine to 15 months.

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