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Even if they aren’t making revenue, small biotechs can face onerous reporting requirements that cost $1 million or more, cutting into the firms’ ability to innovate.
Congress can help these companies with legislation that takes the unique challenges of drug development into consideration, a member of the Board of the Biotechnology Innovation Organization (BIO) testified on June 25.
“One of the most burdensome policies for today’s biotech innovators is Section 404(b) of the Sarbanes-Oxley Act,” Frank Watanabe, CEO of Arcutis Biotherapeutics and Vice Chair of BIO’s Board, told a hearing of the House Financial Services Subcommittee on Capital Markets.
He said his company first faced this reporting burden in 2021.
“To date, we have spent around $11 million on our compliance with Section 404(b)—approximately the cost of running a large Phase 2 clinical trial. And those costs are rising inexorably—for example, last year our auditor fees went up 24%,” Watanabe’s written testimony said.
The hearing, entitled “Reassessing Sarbanes-Oxley: The Cost of Compliance in Today’s Capital Markets,” looked at several proposed legislative reforms.
A painful burden before profits—or even revenue
The Sarbanes-Oxley Act was passed in 2002 to restore investor faith after the Enron scandal, in which the real value of a corporation was obscured from investors.
“But more than two decades later, it’s time to ask whether its most burdensome provisions are still serving investors, or merely discouraging companies from ever going public in the first place,” said Subcommittee Chair Ann Wagner (R-MO) in her opening statement.
Watanabe laid out his company’s challenge with the law.
“Like the vast majority of biotech companies, Arcutis is not yet profitable,” he testified. “Drug discovery is expensive, as are scientists and clinical trials. Since our inception, Arcutis has invested $1.4 billion in developing our products, and we generated no sales in our first six years of business. In our nine years of operation, we have not generated a single dollar of profit.”
As Watanabe explained, the reporting burden fell due because the stock price of his company briefly exceeded the threshold of $700 million, on the testing date of June 30. Suddenly Arcutis had to provide detailed reports of its finances, and developing these reports had an exorbitant cost for a company that was not producing revenue.
Because small biotechs must raise and invest large amounts of capital in the hopes that the drugs they are working on will be approved, many of them face similar situations—relatively high capital and little or no revenue—Watanabe testified.
“One study found that in 2019, Section 404(b) compliance cost emerging growth biotechs an average of over $800,000 per year—that’s the equivalent of eight additional researchers, or an additional eight to 16 patients in clinical trials,” he said.
Potential solutions
“I understand the reason for the enhanced controls required by the Sarbanes-Oxley act. We all remember the egregious business abuses that led to the passage of this legislation,” Watanabe testified.
“But the current thresholds for enhanced compliance requirements enshrined in 404(b) are excessive for small companies like mine, and Congress and the SEC (Securities and Exchange Commission) should take steps to adjust those thresholds so that these onerous requirements do not draw valuable resources away from R&D investments,” he said.
Watanabe described potential solutions, including several ideas incorporated in legislation that was discussed in the hearing:
- Expanding Section 404(B) exemptions: So that more small businesses are able to avoid burdensome reporting requirements.
- Amending Section 404(b) exemption for low-revenue companies: “One approach, as contemplated by the bill attached to this hearing, would be to adjust the public float (from $700m to $900m) and revenue thresholds (from $100m to $250m)” for smaller reporting companies, Watanabe said.
- “Soft triggers” for public float and revenue thresholds: Currently the 404(b) threshold is based on the company’s public float number, which is essentially the value of its publicly held shares, at the end of the second quarter. A “soft trigger” would mean companies are only subject to Section 404(b) if their average value is above the threshold for an extended period, such as 12 months.
- Revising accelerated filer and large accelerated filer definitions: Proposed reform legislation would raise the public float threshold for these categories to $900 million.
- Updating the Emerging Growth Company (EGC) designation: Companies with EGC status have reduced regulatory burdens and reporting requirements so they have lower operating costs. “Under current law, companies lose EGC status once five years have passed since their IPO or if their public float exceeds $700 million, regardless of profitability,” Watanabe testified. “Extending the EGC designation by an additional five years and raising the public float threshold would better account for the long development timelines typical of the biotech sector.”
Dialogue with lawmakers
During the June 25 hearing, Subcommittee Chair Wagner and Rep. Frank Lucas (R-OK) asked Watanabe about his experience with running a biotech while paying for 404(b) compliance obligations. Watanabe replied that his compliance costs had increased significantly, which meant his firm had to take money away from their R&D budget.
Rep. Bryan Steil (R-WI), has proposed reform of EGC thresholds in legislation co-sponsored by Rep. Sam Liccardo (D-CA) and Chair Wagner. Rep. Steil asked about the implications for Arcutis Biotherapeutics of losing EGC status. Watanabe said they spent $650,000 on their audit the year before falling under 404(b) requirements, and once they had to meet their requirements, the cost of the audit doubled to $1.1 million. Last year the cost was at $2.2 million, he said.
Other members of Congress who were supportive of reform at the hearing included Reps. Cleo Fields (D-LA), Troy Downing (R-MT), and Warren Davidson (R-OH).
Rep. Davidson underscored that there is nothing wrong with seeking to improve the Sarbanes-Oxley Act.
“Let’s be clear: This statue is not sacred scripture,” he said.
