Five Prime Advisors
Five Prime Advisors


Some thoughts on valuation, regulation, development, & investment

Some thoughts on proposed changes to the 510(k) regulatory process

While two distinct and largely unrelated legal and regulatory pathways, the process of obtaining legal protection for an invention is a necessary antecedent to a regulatory process resulting in its commercialization and market launch. The following numbers, presented at the WSGR 27th Annual Medical Conference in San Francisco last month (WSGR Medical Device Conference), provides some context with respect to the front end of these pathways that run in series.

From the end of 2000 through May of this year, the US Patent Office allowed 58% of all applications with an average time to issuance of 3 1/2 years, though the number of patents issued between 2012-13 and 2017 declined significantly compared with allowance rates from previous years.  From a peak of about 58 months in 2010, time to allowance declined to about 40 months in 2016 and has been relatively stable the last couple years at around 42 months. There is no clear trend with respect to abandoned applications, though in 2016-17 there was a significant uptick relative to allowances. Data for 2018-19 was not available.

On the regulatory side, the FDA has been responsive for nearly two decades to incentives created by Congress and industry to expedite the device approval process.  In 2012, the device industry agreed to pay to the FDA $595 million over five years to cover its cost of hiring an additional 200 full-time examiners.  The objective of the Medical Device Users Fee Amendments to the FDA Safety and Innovation Act of 2012, which was an extension of two earlier acts of Congress beginning in 2002 with the Medical Device User Fee and Modernization Act, was to sufficiently staff the FDA such that 90% of devices were cleared for marketing within 90 days of 510(k) submission and 98% within 150 days (Medical Device User Fee Amendments). While the FDA continues to fall short of these objectives, total time taken by the FDA to reach an approval decision has decreased steadily since 2009, despite an increase of 32% in review time.

Center for Devices and Radiological Health (CDRH) Director Jeff Shuren has estimated that 20% of current 510(k) applications are cleared based on a predicate device that is older than ten years.  Since the enactment of the Medical Device Amendments in 1976, the CDRH has eliminated the use of 1,758 devices as predicates, 1,477 of which, or 84% having occurred in the last seven years alone, significantly burdening the CDRH as the result of the need to up-classify these safety challenged devices ("FDA Seeks to Overhaul 510(k) Program in Push for Modern Performance Standards").

A modernization of the 510(k) review process based on evolving safety and efficacy standards has the potential to decrease time to market, while lowering costs of approval and increasing overall device safety.  Simply by restricting the predicate device choice to technology that is less than a decade old, much of the time, cost and concern regarding safety associated with device approvals based on older technology will be eliminated.  By disallowing reference to older devices, the up-classification of devices to Class III will occur much less frequently.

If the CDRH is correct in its assessment of the impact of limiting predicate device age to ten years, the result would be a safer industry portfolio, lower burden of regulation, and cost savings to the American taxpayer.

Robert King
The Turkish lira, Trump's Twitter habit, and an independent Fed

A 3.5% sell off in the Turkish Lira today should serve as a warning to President Trump that jawboning the Fed has consequence.  The Wall Street Journal reported this morning that the Turkish central bank left its key one-week repo rate unchanged at 17.75%, 100 basis points less than the median estimate in a recent Bloomberg survey.  With inflation at 15.4% and the lira having lost a quarter of its value since the first of the year, market expectations were that the central bank had no choice but to raise the one-week rate.  Recep Tayyip Erdogan, who won reelection last month on a populist, anti-immigrant platform, recently appointed his son in law, Berat Albayrak, as finance minister.  Mr. Albayrak has written that cheaper credit leads to slower inflation, a view not held by the economic mainstream, and one that if implemented, would likely result in accelerating inflation.

Why should we care?  While Fed watchers have been largely dismissive of Trump’s recent remarks expressing displeasure with the direction of monetary policy - parroting comments made to him by a more informed, but no less ideological Rand Paul - we have seen the outsized effect of his tweets and one-offs in exciting his base while antagonizing Democrats and everyone else.  Fortunately, the president’s rumblings regarding Fed policy don’t elicit the same emotionally charged response from voters as say, immigration or the Russia investigation, but if ongoing and thematic, could have the potential to undermine the legitimacy and independence of the Fed and its mission.

Monetary policy is wonkish by nature.  Expert knowledge and the consistent implementation of policy matters.  Because the hangover, in the form of higher price and wage pressure, often doesn’t occur until a future election cycle, the short-term economic high that comes from easy money is a political siren song.  Which is why – by design – President Trump’s expressed opinion on monetary policy, informed or otherwise, is wholly irrelevant and completely counterproductive.

Robert King
The Haiti I know

Today I am in Gran Bwa, Haiti teaching a class in basic business skills to a roomful of middle aged farmers.  It is the eighth anniversary of the 2010 earthquake that killed 313,000 Haitians and displaced another 1.8 million.  At 4:53 PM, we commemorate the tragedy with a moment of silence.  As if on cue, a young child within earshot begins crying midway through the silence and stops abruptly at its passing.

Myself and two colleagues are teaching a 4-day basic skills course for entrepreneurs.  We are members of a small NGO loosely associated with the Roman Catholic Church.  Since 2001, we have provided healthcare, education, water, and microlending resources to a remote, undeveloped region east of Port-au-Prince that borders the Dominican Republic, known as Grand Bois, or “Gran Bwa”, in the Creole.  It is mountainous, remote and beautiful, with 4,000 foot ridges tumbling precipitously into dark, verdant valleys.  Large swaths of the region are accessible only by foot or burro.  It is an enchanting, bucolic, and largely undeveloped corner of the Caribbean.

Since 2012, we have taught this course three times and have made 21 loans of between $300 and $3,500 to those graduates who have taken the skills taught in our classes to develop a business plan that articulates a strategic vision, identifies a market need, proposes a commercial solution, and constructs a credible operating and cash flow forecast and capital budget.  These loans have been used to purchase, among other things, a mechanical bread kneader, agricultural supplies, and livestock.

Due to the inaccessibility of the region we have focused on investment in agriculture.  While manufacturing or assembly may generate more value-add down the supply chain, the cost of transporting goods to Port-au-Prince more than offsets the benefit of producing for a non-local market.  More importantly, our students want to remain farmers.

Beverly Bell, in her book “Fault Lines”, tells of conversations she had with Haitians who were at the time of the earthquake residents of Port-au-Prince and were relocated by the national government to the Central Plateau, a rural and lightly developed region in the center of the country.  Striking to her was the significant percentage of those she interviewed who would have preferred to remain in the countryside if it were economically feasible.  This may be due to their perception of chaos and lack of opportunity existing in the capital post-earthquake, but based on my experience working in Haiti the last eight years, I suspect it is more a testament to the spirit of the Haitian spirit and its longing for connectedness to the land.

For these reasons, we have focused our lending activity on investment that has the potential to increase agrarian efficiencies and keep families on their ancestral lands.  To date, 19 of our 21 loans have been repaid in full.  One is in workout, the other in default.  (Our funding more than one bakery in the region was a mistake for what in retrospect were obvious reasons.)  Our 5% default rate (not including the one loan in workout) is testament to the importance of combining skills acquisition with access to capital.  The 21 entrepreneurs we empowered with training and funding returned to their families and farms to start businesses, create jobs and better the lives of those they touch.

President Trump’s recent unfortunate comments regarding Haitian undesirables and those that come from “shithole countries” is in sharp contrast to my experience of the rural Haitian – our stakeholders – that if given the choice of supporting a family working the land or emigrating to NYC to drive a taxi will inevitably choose remaining a farmer in their homeland.  They are a proud and patriotic people who simply seek the same opportunities we take for granted in the United States.

Robert King
Repeal of the Volker Rule

The Financial Choice Act of 2017 seeks to repeal the so-called Volcker Rule, which prohibits banks from engaging in proprietary trading, and restructures the Consumer Financial Protection Bureau, created by the Consumer Financial Protection Act of 2010.  Repeal of the later would subject the CFPB to congressional oversight, including the appropriation process and judicial review.  Its director would be replaced with a commission comprised of members from both parties. While this ostensibly appears to be a bipartisan step forward, given the polarized rancor of the two parties surrounding issues of consumer protection, repeal effectively neuters the commission’s ability to pursue enforcement of CFPA-created consumer protection laws.  Further, in the unlikely event that the commission were to find common cause, the proposed act would greatly limit the authority of its members to take action against firms engaging in abusive practices.

The Volcker Rule, which is part of the sweeping and transformative Dodd–Frank Wall Street Reform and Consumer Protection Act of 2010, was intended to ensure that institutions whose failure could bring down the financial system are not engaging in the sort of risky trading practices that contributed to the financial crisis.  The failures of Bear Stearns and Lehman Brother, and nearly Goldman Sachs, were the result of outsized bets these firms took for their own gain. Legitimate market making activity does require a dealer to take trading positions based on a directional view of the market.  However, rules regarding the size of these positions would be relatively straightforward to formulate.  Republicans in Congress argue that the Volcker Rule has resulted in a loss of liquidity in more thinly traded securities, particularly corporate bonds.  This may be. But it wasn’t elephantine bets on corporate paper that brought down Bear and Lehman.

Jeb Hensarling (R-Texas), author of the current legislation seeking to “repeal and replace” Dodd-Frank, makes a curious argument that a bank’s equity holders have a strong incentive to keep risk-taking on the part of management in check.  While one would believe that the power of aligned incentives offsets the underlying agency issues of management risk-taking to the detriment of shareholders, government bailouts are still fresh in the memories of bank CEOs and their risk managers.  My guess is that without the regulatory teeth of Dodd-Frank, the issue of moral hazard and excessive risk-taking will remerge as a serious threat to our financial system.

Like much of the current Republican legislative agenda, there is something wide-eyed and facts-be-damned about Hensarling’s untested belief in the power of markets.  In contrast, Alan Greenspan, that disciple of Ayn Rand and great champion of unbridled capitalism, in testimony before the House Committee on Oversight and Government Reform on October 23, 2008, confessed: “Those of us who have looked to the self-interest of lending institutions to protect shareholders’ equity, myself included, are in a state of shocked disbelief.”

Chairman Greenspan, to his credit, had the intellectual honesty to admit that his economic and political ideology had failed him, and that the policies he promulgated as Fed chief had contributed to the market bubble that preceded its inevitable collapse.  While we may earnestly believe something to be true, it doesn’t necessarily make it so.

Peter Meyers
Memories Are Short

Between November 2008 and April 2009, the United States suffered its worst economic crisis since the Great Depression. Nine million jobs disappeared. Unemployment rose to over ten percent. Eight million Americans lost their homes to foreclosure.  The impact of the crisis was widespread and devastating.

As a result, Congress enacted legislation and in July 2010 President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act.  The legislation significantly reduced the risk that regulators would be forced to rescue a failing financial institution or risk collapse of the entire sector.  If the Fed had thrown Lehman Brothers a lifeline, it is quite possible that the contagion that swept through the financial system and ultimately engulfed the real sector, where most of those nine million jobs were lost, would have been avoided.

The Hobson's choice that the Fed faced in choosing not to rescue Lehman had catastrophic consequences.  When the dust settled, American corporate icons many believed would be immune to collapse had received taxpayer funds.  If not for the Obama Administration's aggressive intervention, General Motors and thousands of jobs it supports, wouldn’t exist today.  There are few serious economists who believe that massive government intervention wasn’t needed to keep the economy from slipping into a 1930s style depression. Yet memories are short. Michigan went Trump in 2016 and the Republicans are dismantling Dodd-Frank.

A bill sponsored by Jeb Hensarling (R-Texas) that largely guts Dodd-Frank is ready to be brought to a vote of the House. The Financial CHOICE Act of 2017 repeals many of the safeguards created under Dodd-Frank, including the important Volker Rule.  Most troubling, the bill removes the Financial Stability Oversight Council’s authority to designate non-bank financial institutions and financial market utilities as “too big to fail,” or “systematically important,” in the language of Dodd-Frank.

Reforms under Dodd-Frank ensured that financial institutions deemed systematically important would have the capital and liquidity to weather economic and self-created storms, and in the event of failure, that there exists a process ensuring an orderly liquidation that doesn’t buffet the financial system or require taxpayer assistance.  CHOICE eliminates the FDIC’s orderly liquidation authority under Title II of Dodd-Frank and creates a new chapter in the bankruptcy code providing for the winding down of a failed institution. MetLife has successfully sued in Federal court to have its “too big to fail” designation removed.  Suits brought by other companies designated as such, including AIG and GE’s financial unit, are winding their way through the courts.

In a bankruptcy process, an announcement of restructuring by a systematically important bank or market utility has the potential to significantly destabilize the financial system. Without a credible liquidity backdrop which doesn’t exist in bankruptcy, counterparties run for the exits, turning restructuring into a liquidation with losses that could exceed hundreds of billions of dollars.  Moreover, Section 23A of the Federal Reserve Act restricts a commercial banking subsidiary of a bank holding company from lending funds borrowed from the Fed to a broker-dealer affiliate.  At present, Title II of Dodd-Frank enables the Fed to act as such a backdrop giving it the authority to provide the liquidity required for an orderly winding down.  The Republican plan to repeal Title II will have dire consequences in the next financial meltdown.

Peter Meyers