Attack of the Shorting Bass: Does the Inter Partes Review Process Enable Petitioners to Earn Abnormal Returns?
Read the addendum to this ArticleIntroduction
In equity markets, speculators attempt to profit from changes in stock prices. One strategy for doing so is to obtain information earlier than other market participants and then profit as that information spreads and market prices adjust in response to that new information. The Rothschilds’ trading on the information of Wellington’s victory at Waterloo is a classic example of that strategy. Another strategy is to create market moving news, whether true or false. Speculators might also attempt to affect the underlying value of a company by altering the legal environment—for example, by pushing for legislation that would increase the profitability of a corporation’s business or reduce the value of its assets.
Speculators could also affect stock prices by challenging the validity of patents that a publicly traded company owns, a strategy that changes to the patent review process have potentially made more profitable. In 2015, the Coalition for Affordable Drugs (CFAD), a series of hedge funds managed by Kyle Bass, the head of Hayman Capital Management LP, challenged the validity of pharmaceutical corporations’ patents through a review process under the U.S. Patent and Trademark Office’s (USPTO) administration called inter partes review (IPR). Bass filed 32 challenges against pharmaceutical patents as of September 2015 and announced plans to challenge more before the Patent Trial and Appeal Board (PTAB). Bass explained that the purpose of his IPR challenges is to invalidate weak patents that impose costs on consumers and thereby make drugs of those pharmaceutical companies more affordable. Some pharmaceutical companies that own patents that Bass has challenged have characterized Bass’s IPR challenges as an investment strategy that abuses the IPR system to profit by affecting pharmaceutical companies’ stock prices. Celgene Corp. and Pharmacyclics Inc., among other companies, have asked the USPTO to dismiss Bass’s IPR challenges against their patents, arguing that those challenges are “an abuse of process.” In a motion for sanctions against the CFAD filed on July 27, 2015, Celgene alleged that “each CFAD entity’s sole purpose is to ‘benefit [Mr. Bass’s] investments’ by filing IPRs and profiting from resulting changes in stock prices.” The real parties in interest in the CFAD’s IPR challenges, including those against Celgene’s patents, are Hayman Credes Master Fund LP, Hayman Capital Management LP, IP Navigation Group LLC, other entities under Bass’s ownership, and Bass himself. Biogen Inc., another pharmaceutical company with patents that Bass has challenged, has demanded that Bass’s fund release documents that would shed light on whether Bass has shorted stocks of pharmaceutical companies in connection with the filing of IPR challenges.
By the end of August 2015, the PTAB responded in part to the criticism that Bass might be filing IPR challenges for other business objectives, which could constitute an abuse of the IPR process. On August 24, 2015, the PTAB released its decision on Bass’s first two challenges denying the “institution” or consideration of Bass’s petition against Acorda Therapeutics’s patent. Although the PTAB did not address the claim of abuse of process, the dismissal of Bass’s first petition signaled that Bass might not be successful in invalidating “less valuable” patents through the IPR process. In a separate case, the PTAB issued a three page order on September 1, 2015 requesting the CFAD and NPS Pharmaceuticals to submit briefs addressing whether the CFAD’s IPR challenges against two of NPS Pharmaceuticals’ patents should be dismissed for abuse of process. The PTAB notably required that the parties address in the briefing “to what extent, if any, the business objective or intent of the Petitioner should be considered in reaching a determination of abuse of process.”
Bass countered some of the criticism that the pharmaceutical companies launched against him. In a response to Celgene’s motion for sanctions submitted on September 2, 2015, the CFAD argued that financial gain being a petitioner’s motive for filing an IPR challenge provides no basis for establishing wrongful conduct. The CFAD stated that “Celgene’s motion . . . makes the curious argument that filing IPR petitions with a profit motive constitutes an ‘abuse of process.’ Yet at the heart of nearly every patent and nearly every IPR, the motivation is profit.” In response to Celgene’s accusation that the CFAD’s motives are not entirely “altruistic,” the CFAD answered: “That is a truthful irrelevancy. The U.S. economy is based largely on the notion that individual self-interest, properly directed, benefits society writ large.” The CFAD acknowledged, in fact, that its “IPRs are part of its investment strategy” but that “it will only succeed by invalidating patents, which would serve the socially valuable purpose of reducing drug prices artificially priced above the socially optimum level.” The CFAD also argued that even if Bass were short selling patent holders’ stock for financial gain (as the press speculated), such an action would not constitute an abuse of process. The CFAD cited to the Securities and Exchange Commission, which has stated that short sellers who short companies with overvalued stock can actually add to stock pricing efficiency by informing the market of the true economic value of those companies.
We do not address whether the short-selling strategy in which journalists speculated Bass was engaging would constitute market manipulation. We analyze the effect that Bass’s challenges had on the stock price of the pharmaceutical corporations that own the challenged patents. On the basis of the observed pattern of returns after a challenge, we find that the market reactions to Bass’s initial inter partes review petitions could have provided him with the opportunity to profit by shorting a stock and quickly closing out his position. However, we find that, after the initial few IPR challenges, subsequent challenges no longer provoked a strong response in the capital market. That muted response implies that a trading strategy based on short term price reactions to an IPR challenge would not have been profitable after the initial few challenges. Furthermore, later challenges actually produced strong responses in the opposite direction of what the short-selling hypothesis would predict—that is, later challenges produced statistically significant positive abnormal returns. The PTAB’s first two rulings on Bass’s challenges as of September 1, 2015, also induced statistically significant positive abnormal returns for the challenged patent holder Acorda Therapeutics. An analysis of additional PTAB rulings could reveal whether the price reaction is particular to the precedential value of the PTAB’s first ruling or the PTAB’s rulings will affect the returns of those companies Bass challenged.
Part II summarizes the history of the inter partes review and the purpose of its creation. Part III examines the descriptive statistics of the companies that held patents that Bass challenged through inter partes review. We present an event-study framework to analyze the effect of Bass’s 2015 IPR challenges on the stock prices of the pharmaceutical companies with challenged patents. Part IV presents the empirical results, explains the statistical significance of those results, and analyzes the implications of the market response to Bass’s IPR challenges. Part V proposes potential lines of analysis of imminent challenges.