Attack Of The Shorting Kyle Bass: Does The IPR Process Enable Petitioners To Earn Abnormal Returns?
J. Gregory Sidak & Jeremy O. Skog
Abstract
The Patent Trial and Appeal Board recently instituted a review process called inter partes review that provides a faster review of patent validity than previous methods. The inter partes review has less restrictive rules about which entities can file a petition challenging a patent. Investment firms have taken advantage of these changes. We test whether the patent challenges made by one investment manager negatively affected the stock prices of the challenged companies. Through an event study, we show that the initial challenges created significant negative abnormal returns. Since then, market reactions have become muted and no longer consistently produce returns that are either negative or statistically significant.
Attack Of The Shorting Kyle Bass: Does The IPR Process Enable Petitioners To Earn Abnormal Returns? – Introduction
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 in-crease 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 pa-tents that a publicly traded company owns, a strategy that recent changes to the patent review process has 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 called inter partes review (IPR), under the U.S. Patent and Trademark Office (USPTO). As of October 2015, Bass has filed twenty-eight challenges against pharmaceutical pa-tents and announced plans to challenge more before the Patent Trial and Appeal Board (PTAB). Kyle Bass explained that the purpose of his IPR challenges is to in-validate weak patents, which impose costs on consumers, and thereby make those drugs more affordable.
Some pharmaceutical companies that own these patents have characterized Kyle Bass’s 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 Kyle 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.
Kyle Bass has countered some of the criticism that the pharmaceutical companies launched against him. In a response to Celgene’s motion for sanctions, the CFAD argued that financial gain being a petitioner’s motive for filing an IPR challenge provides no basis for finding 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 that its “IPRs are part of its in-vestment 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 Kyle 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.
While PTAB has denied Kyle Bass’s first two challenges, as of September 2015, it has also denied Celgene’s motion to sanction Bass under the claim that Bass seeks to profit from his IPR challenges. The PTAB stated that “[p]rofit is at the heart of nearly every patent and nearly every inter partes review. As such, an economic motive for challenging a patent claim does not itself raise abuse of process issues.” The PTAB further stated that a petitioner like Bass who has “no competitive interest in the patents [he] challenge[s] is allowed to file a petition under the Leahy-Smith America Invents Act.” The PTAB added that the purpose of the IPR process is not limited to providing a less costly alternative to litigation and that the system was “designed to encourage the filing of meritorious patent-ability challenges, by any person who is not the patent owner.”
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