One key loophole in the FDA approval process could leave the door open for small drug developers to walk away with hundreds of millions of dollars. But not all drug companies get an equal shot at this huge advantage. Here’s a glimpse at how it breaks down – and how one of my favorite small-cap stocks could profit in the process…

Some of you know that for much of my career, I worked in and around the nonprofit research side of medical regulatory policy issues. It’s a thankless endeavor because drug regulation only sounds like such a good idea to the uninformed. Who could be against the FDA’s stated mission of protecting us from dangerous drugs, after all? Anybody who questions the FDA is considered by many to be a dupe of big business.

Nothing could be further from the truth, as I will explain.

The problem is this: Regulators impose costs that are extremely difficult to measure. We hear about birth defects caused by thalidomide when pregnant women ignored warning labels and used the anti-nausea drug to self-treat morning sickness. We don’t hear about the people who died of malnutrition because thalidomide, the only drug that let them eat normally, was yanked off the market.

We hear about side effects caused by approved drugs. We almost never hear about the suffering and death caused by not approving drugs. The pro-government mainstream media, of course, inevitably fail to present regulatory issues fairly.

In addition, economists have long pointed out that regulatory agencies tend to be “captured” by those they regulate. Over time, due to various factors, regulators tend to protect the established interests of the industries they regulate. This was clearly the case with the home mortgage industry, as I’ve explained before.

In the case of drugs, the same dynamic exists. The barriers that must be vaulted by new drug makers are enormous. These barriers are both time-consuming and expensive, which is often the same thing. The best way to understand FDA rules, in my opinion, is to realize that the imposed costs are just high enough to keep Big Pharma safe from most upstart innovators.

FDA Approval Process: The Regulatory Rabbit Hole

While FDA-imposed costs and delays are enormous, they also present opportunities for the clever. Because artificial barriers can be bypassed politically, there is great profit in doing so. The higher the barrier, the greater the profit for those who can find a way through.

To judge the size of those costs (and profits), let’s take just one estimate published in the journal Health Affairs. A team of economists from Duke University focused only on the costs of delays imposed on companies with potential blockbuster drugs. They calculated that a priority ranking system, a shortcut through the regulatory wonderland, would reduce the approval process from the current 18 to about six months. Moreover, they estimated that the value of such a shortcut would be $300 million.

This is where things really get interesting. This hypothetical shortcut, a regulatory rabbit hole, actually exists. It was created specifically because the high cost of drug approval, as well as development, keeps many important drugs off the market.

If the cost of developing and approving a drug is greater than its expected profit, the drug is unlikely to be produced. This is often the case when a relatively small number of people have a disease. Alternatively, many people may have the disease, but the victims lack the resources for even basic necessities. These are known as orphan diseases. Drugs that treat them are orphan drugs.

Duke University economists proposed, in the 2006 article I linked above, “priority-review vouchers.” They are, explicitly, a way to exploit the FDA barriers. In return for developing a cure for a tropical orphan drug, they proposed a kind of “Get out of FDA Jail Free” card. Anyone holding such a voucher could take their proposed drug to the head of the drug approval line.

Today, it is the law. Specifically, it is SEC. 524. [21 USC §360n] Priority Review to Encourage Treatments for Tropical Diseases. It was introduced in 2007 and made part of the Federal Food, Drug and Cosmetic Act (FD&C Act) in May 2008.

Most importantly, these fast-track vouchers can be sold. As I have already pointed out, their economic value was estimated at $300 million by the economists who designed the legislation.

Now connect the dots. The voucher legislation specifically lists 16 disease cures that will earn the fast-track vouchers. One is dengue/dengue hemorrhagic fever. Dengue is only the tip of the virus iceberg, however, since the law also covers “Any other infectious disease for which there is no significant market in developed nations and that disproportionately affects poor and marginalized populations, designated by regulation by the secretary.” This expands the list of tropical orphan virus diseases to hundreds, if not thousands.

I told my Breakthrough Technology Alert readers just a few weeks ago that one of our portfolio holdings had entered into an agreement with top dengue researcher at the University of California, Berkeley. I don’t believe that our company would have exposed its technology and secrets to her if it wasn’t confident that she would validate its platform.

What’s this worth? Let’s be conservative and say that the Duke University economists were $100 million too high in their valuation of such a voucher. I think these vouchers could actually be worth more than that, for one reason. Drugs that are “first to market” often win out against even superior competitors. A priority review voucher could be a license to kill for a Big Pharma company worried about competition.

Nevertheless, Bill Gates said in 2008 that the priority-review vouchers, “could be worth hundreds of millions of dollars.” I’ve found, from personal experience, that arguing with Bill Gates is usually a bad idea. So let’s be ridiculously conservative. “Hundreds of millions of dollars” in its very strictest sense is $200 million. So we won’t quibble.

There are a few companies out there right now that could profit from the FDA approval loophole, but one in particular springs to mind. While I can’t give you the name of the stock I’m talking about today – it wouldn’t be fair to my current Breakthrough Technology Alert readers, after all – I can invite you to join my exclusive research advisory. The details can be found here…

Incidentally, we know that small biotechs are particularly subject to irrational vacillations. They are also a favorite of short attackers. It’s inevitable that this company will be bouncing in weeks and months to come. Right now, however, almost nobody knows what I just told you. If you plan to buy, be patient and pick up stock when prices are down.

For transformational profits,
Patrick Cox
Penny Sleuth

March 17, 2010

Patrick Cox

Patrick Cox has lived deep inside the world of transformative technologies for over 25 years. In the 1980s, he worked in computer software development and manufacturing. By the mid-1990s, he worked as a consultant for Netscape — the company that handled 90% of all Internet browsing traffic at the time. InfoWorld and USA Today have featured Patrick's research numerous times. He's also appeared on Crossfire and Nightline. Patrick has been quoted by The Wall Street Journal and Reason magazine. His expertise brought him to Agora Financial, where he now heads Breakthrough Technology Alert, the only place you'll find the truly transformational technologies that offer exponential gains.

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