For CytRx’s Insiders, What a Difference a Day Makes
CytRx (NASDAQ: CYTR) investors had a lot to be happy about last week. The good times came on Wednesday, Dec. 11, after the small cap biotech announced encouraging summary results from a mid-stage clinical trial of its doxorubicin conjugate, aldoxorubicin, in patients getting their initial treatment for soft tissue sarcoma. This announcement sent Los Angeles-based CytRx’s stock up 68 percent that day, and another 52 percent on Thursday, for a two-day grand total of 156 percent.
Congratulations to those of you who own the stock! Double congratulations if you were lucky enough to significantly increase your ownership on the day before the big announcement, like the company’s board of directors and management did.
Before I go on to describe what a mockery of corporate governance this is, I’ll first touch on the good news, which is that the drug seems genuinely intriguing so far in this early stage of development. Doxorubicin is a commonly used chemotherapy in many types of cancers, but its use is limited by serious toxicities and adverse events, especially to the heart. To improve on a drug like that would be meaningful, and possibly lead the way to a whole platform of other uses for this approach further on down the road.
Without getting too technical, aldoxorubicin’s concept is to attach doxorubicin to an acid sensitive linker that binds to albumin in the blood. The theory is that hungry tumors aggregate albumin more than healthy tissue, where the acidic environment causes doxorubicin to delink and do its damage in a targeted way and at higher doses. If you are interested in learning more about the science, you can read about it on CytRx’s website here. For the clinical trial results, click here.
There is only one catch: just as I was doing some investment research and, frankly, becoming interested in the opportunity I stumbled onto something so questionable and shocking that I had to do a triple-take. I think this is an interesting story because it illustrates how poor corporate governance can make a company untouchable for many investors, at least for me.
The big glaring problem here is that CytRx released the positive clinical trial results exactly one day (actually 12 hours) after the board of directors granted themselves and the company’s named executives an annual round of new stock options, which also happened to be significantly larger than last year’s grant. What a coincidence! Note: Adam Feuerstein at TheStreet.com has done a nice job reporting on this issue here as well.
When I asked David Haen, CytRx’s vice president of business development, to comment on the timing of the option grant ahead of the data release, here’s what he said via e-mail.
“Our board meets at least quarterly, and those meetings are typically scheduled months in advance if not in the prior year. Option grants are typically issued annually at the December meeting. If you look at last year, they were granted on December 10 as well. This is the normal course of business irrespective if we had clinical results. I believe it would look far more suspicious if we had waited for the data to be released and then had to decide on a specific day following the market’s reaction. That could easily be viewed as trying to time the market.
As for the clinical results, we released them after we received the analysis from our CRO. We wanted to hold a conference call including Dr. Chawla, our principal investigator, because of the significance of this data to CytRx. Because we have a large retail shareholder base and many do not follow the market as closely as professional investors, we wanted to announce the conference call the day before to allow them to participate on the call. We also did not want to disadvantage folks on the west coast from joining since it was held at 7:30am PST. I hope that this clarifies the timing questions.”
To understand how unusually coincidental this is, and the significance of it happening one day after the grant, you have to understand the basics of options. Because these were granted on Tuesday, the option strike price equaled the closing price of the stock that day, which was $2.39. Therefore, if CytRx’s stock is trading for $2.39 or less on any give day, there is no reason to exercise the options because they would have no value. However, a stock price above $2.39 could translate into considerable value.
CytRx’s stock closed at $4.02 on Wednesday. So these options were already “in the money” so to speak only hours after they were granted at an exercise price of $2.39—a comparably low price. On Thursday, the stock closed at $6.12. This is significant because it translates into a huge windfall (at least on paper) after only 12-48 hours. If CytRx had put out the press release a day or two earlier (or conversely if the options were granted a couple days later), the stock options would have been worth much less.
Below is a table I put together using info from CytRx’s regulatory filings, which lists each person’s option grant. I’ve shown how the grants significantly grew in value over just matter of days.
Option Grant on 12/10/13 (vs. last year)
Grant Value on 12/10/13
Grant Value on 12/11/13
Grant Value on 12/12/13
|John Caloz||CFO||150,000(100,000)||Every month over 36 months||$0||$244,500||$559,500|
|Steven Kriegsman||CEO/Director||925,000(500,000)||Every month over 36 months||$0||$1,507,750||$3,450,250|
|Ben Levin||GC/SVP Legal Affairs/Secy||300,000(100,000)||Every month over 36 months||$0||$489,000||$1,119,000|
|Daniel Levitt||EVP and CMO||500,000(100,000)||Every month over 36 months||$0||$815,000||$1,865,000|
|Douglas Wieland||SVP-Drug Development||150,000(100,000)||Every month over 36 months||$0||$244,500||$559,500|
*Mr. Selter gifts his options to another party
As you can see, the timing of the announcement might have been worth up to $11M to these insiders over the 48 hours after its release. What a difference! These awards, of course, can still go up or down in value over time. But each recipient (the directors especially) are in a position to make a quick payday if they so choose.
I’m not against rewarding executives for creating value (far from it), but keep in mind these insiders have been receiving options for years. Some of those options granted in the past did increase in value considerably this week. It is the ones that were granted last Tuesday that are the issue because I would argue they have turned into a payoff instead of an incentive for greater future performance, as options are meant to be.
This is troubling from a corporate governance standpoint for the following two reasons:
First, it could mean that the timing of the data release vis–à–vis the option grants was gamed this way. The question here is did the company’s management specifically wait until after the options arrived to release the data? That would be the worst-case scenario because I personally believe it would be akin to insider trading. Imagine if an investor had purchased options on hundreds of thousands of shares of CytRx stock the afternoon before the data was released. You can bet he or she would likely be receiving an interesting phone call from the SEC someday. To state the obvious, a company’s insiders have a lot more information than any investor ever would. I don’t see how the way they increase their ownership should be scrutinized much differently.
In this case, nobody outside of the company will likely ever know the facts of who knew what and when, but there are a few details that are highly coincidental and hard to ignore. For example, this was an open label trial, which means researchers on the study knew which patients were getting the CytRx drug and which were getting the standard treatment. Furthermore, CytRx had already presented preliminary data on secondary endpoints from the trial here as recently as October 31st, and earlier still here on September 30th. Therefore, they must have had, at a minimum, an inkling of how the trial results would look around the time the December grant was coming up.
The second thing it could mean is that the board of directors was simply asleep at the wheel and has no clue what constitutes best practices. Everybody knew this data was coming in December, because CytRx had already told investors to expect that. So why not hold off on the options and other compensation matters until after the binary event had passed? I bet if you took a poll of 100 boards of directors about what to do in that situation, almost all would have chosen to hold off until after the event had taken place in order to avoid the perception of a conflict of interest.
What does all this mean for investors? Well for me at least, it makes CytRx untouchable. It is just too big of a red flag. The problem is that in drug development the amount of information available inside and outside of the company is more asymmetrical than in any other industry, so you have to be careful when you are the person on the outside. If a company takes advantage of its informational edge once, investors cannot risk letting it happen again. Especially for a small company trying to break into the next level, it would have been best to proceeded with caution in order to gain long-term investor trust. Once you have lost that, it is hard to get back.
Disclosure: I have no position in CytRx. I never have in the past, and as I describe above, do not intend to in the near future.