Supreme Court's ruling on genetic tests will make a bad business worse


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  • There’s no reason to be optimistic that a new business model, and a new set of incentives will emerge to ignite the next wave of innovation.

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  • The method for detecting gene sequences can still be protected by patents. But that may provide little protection going forward.

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  • The collection of anti-patent groups that led the fight against Myriad Genetics are celebrating their win.

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Whatever your view on the legal merits of yesterday’s decision by the U.S. Supreme Court, ruling that the discovery of gene sequences is not patentable, the verdict is one more challenge to an industry that’s already on the ropes. The decision will make it much easier for firms to engineer around a competitor’s discoveries, and much harder to sustain investment in this industry.

In recent weeks, the Food and Drug Administration has announced that it intends to regulate diagnostic testing services as medical devices, putting the entire industry under the agency’s regulatory thumb. FDA will subject many tests to long and costly clinical trials to prove that new tests have the ability to not only inform clinical judgment, but also improve clinical outcomes when doctors deploy them.

This is a regulatory requirement, referred to as clinical utility, which was previously reserved for the approval of new drugs. The rich returns on a drug can help underwrite the investment needed to run the required trials. Few diagnostics earn a return that can offset the investment needed to satisfy such a mandate.

On the reimbursement front, Medicare has abruptly changed the manner in which it pays for most diagnostic tests. The agency has reduced reimbursement rates across the board for tests. In some cases, the cuts are substantial. At the same time, Medicare has curtailed coverage altogether for some of the newer, more innovative tests, where the agency says that tests lack data demonstrating the effectiveness of the diagnostic.

All of this should strike a cautionary note for policy makers who champion the idea that “personalized medicine” will improve patient care while lowering costs. That includes the President, his Cabinet, along with most members of Congress.

The ability to more effectively diagnose disease, and target treatments, is predicated on a new generation of diagnostic tests that allow therapies to be more precisely tailored to disease and to the needs of individual patients. But the investment model that made our current crop of diagnostics tests possible is broken. Who are going to develop these new tests now?

The drug makers, who only pursue tests that advance the prescribing of their medicines? Academic researchers, who can’t commercialize products, let alone comply with modern regulation? The government?

There’s no reason to be optimistic that a new business model, and a new set of incentives will emerge to ignite the next wave of innovation. Nor reason to believe that the government, or academia, or drug makers will fill the void.

What the SCOTUS decided, in a nutshell, is that patents can no longer protect the content of gene sequences, nor protect the discoveries that correlate particular gene sequences (and mutations) to the understanding of specific disease states.

This has broader implications than the breast-cancer genes that were the subject of the court’s ruling, and the company involved in that decision, Myriad Genetics [NASDAQ:MYGN]. The method for detecting gene sequences can still be protected by patents. But that may provide little protection going forward. Methods are easy to obviate in this industry. The full implications will take time to unfold.

The problem is that, in the diagnostics space, it’s very easy to engineer around someone’s process for finding a gene or measuring a protein. There are many ways to skin a cat in this field. No matter how broad a company’s protections around the way it goes about measuring a protein it has discovered, or detecting a gene sequence it has uncovered, it’s very likely that another company could figure out a way to do the same in a novel way, and get around the originators IP.

The decision could also have a much broader reach, putting at risk other discoveries of nature that nevertheless lead to substantial medical and technological advances.

The New York Times speculated that patents on bacterial genes that might be useful in producing enzymes or biofuel, might also now be in jeopardy. An analysis in Nature Biotechnology in May identified more than 8,000 genes (many from plants and organisms) that might be at risk in the Myriad decision.

The collection of anti-patent groups that led the fight against Myriad Genetics are celebrating their win. But aside from some immediate cost-savings that the decision might deliver to consumers, who will get broader (and cheaper) access to today’s crop of diagnostic tests, what does the victory deliver for our future?

The decision has broad implications. Some are immediate. A handful of companies (Chiron, Qiagen, and Roche, among others) market panels of tests for measuring the resistance of viral infections like hepatitis C, HPV, and HIV. Some of these firms maintain intellectual property around the different viral sequences that can predict resistance to drugs, or the probable course of a disease. These patents may be vulnerable as a result of the ruling.

Going forward, firms may be less likely to share their IP, and publish results. More companies will try and develop proprietary algorithms that correlate multiple measures of gene and protein outputs in complex equations that can predict certain outcomes. Firms will protect these algorithms as trade secrets. The company (Myriad Genetics) that lost yesterday’s SCOTUS ruling was already working on one such test for predicting breast cancer. Myriad said that the new test would eventually replace the simpler, gene-based test that was the subject of the lost suit.

Tests will, in effect, become black boxes. Of course, if FDA steps in to regulate this space, it will force these trade secrets to be disclosed. The industry’s reaction to yesterday’s ruling may, in that respect, hasten the ensuing push for more regulation.

In the end, if the technology can’t be protected in this field, and the IP reimbursed with above market rates of return on invested capital, then the diagnostics industry will mostly function as a service business, not one led by innovation and new IP.

This evolution toward a service model, with service industry type margins and trading multiples, has been already underway. The number of diagnostic companies that could earn high-technology type returns on their IP is a scant few.

This doesn’t bode well if we seek a future filled with new innovation.

Most of the existing diagnostic companies make their money off the platforms they market to run the tests, or the sheer volume of diagnostics they perform. But not the proprietary IP embedded in their discoveries, or the tests themselves.

This may work fine for driving down costs of today’s diagnostics. But it’s not a recipe for a whole lot of new innovation.

Things are so dim; there might actually be a role for Congress to contemplate a more comprehensive approach to the handling of diagnostics. In places, the SCOTUS ruling seemed to acknowledge as much. Legislation could strike a more careful balance between reasonable regulation, proper reimbursement, and the need for financial incentives along with the appropriate protection of legitimate IP.

Right now, when it comes to diagnostics, there are a host of policy uncertainties. It’s a big reason why venture capital is shunning this field.

The returns needed to attract expensive, high risk capital simply can rarely be had in this industry. It’s why we’re likely to see fewer novel tests in the future. And why we should be diagnosing a grimmer prognosis for personalized medicine.

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