Despite Worries About New IP Rules, Biotech Companies Are Staking a Claim to California’s $3 Billion Research Lode.

Robert Klein convinced Californians to part with $3 billion of their taxes to fund stem cell research. Proposition 71, the state referendum he championed, was handily passed by state voters in 2004, creating the largest source of embryonic stem cell funding in the world.

Klein, a Stanford-educated lawyer, transformed himself into a full-time medical research activist from a real estate investment banker after his son Jordan was diagnosed with juvenile diabetes in 2001. Now he’s the chairman of the Independent Citizens Oversight Committee (ICOC), the 29-member body that oversees the California Institute for Regenerative Medicine (CIRM), the state agency created by his proposition. Klein won state funding by stressing that embryonic stem cell research is vital to fighting disease-from the rare and always fatal (neurodegenerative ailments like ALS) to the alarmingly common and chronic (diabetes). But Klein maintains the rhetoric and stance of a combative underdog. On a recent sunny spring weekend he huddled in a darkened San Francisco conference room with 80 or so
patient-activists, rallying them against conservative and right-to-life politicians and groups who have criminalized such research in some states. "How many people do you think it takes to start a revolution?" he asked the crowd. "I can tell you, it’s many less than the people in this room."

This battle for public opinion must be fought not in Washington, D.C., Klein says, but in Sacramento and Albany and Topeka. States are the new leaders in funding stem cell research. Seven months into the George W. Bush presidency,
in August 2001, his administration cut off federal funding for any research that used human embryonic cell lines derived after that date. In addition to giving hope to patients, states see investing in biomedical research as a way to jump-start homegrown biotech companies and create high-paying jobs. Klein also believes that massive expenditures for the Iraq war will be a long-term crimp on federal spending. "The real future of medical research in this country will rest with the states," he claims. Klein may be overstating the case at this point. The federal National Institutes of Health awarded over $650 million in stem cell research grants last year, most for nonembryonic stem cell research. But even with possible policy changes by a new president in 2009, states have already taken the lead.

For bioscience companies that look to patents to protect profits, the rules of the game are changing-or rather the rules of many new games, as each state has the right to set its own IP policies for research that it funds. And if California is any guide, state funding may usher in long periods of uncertainty, and new demands for a much larger share of the proceeds from any discoveries than what the life science industry has seen before.

In California, it took more than two years from when the referendum passed to clear out legal challenges brought by conservative groups and to fully fund the stem cell agency. By law, the board that oversees it includes (in addition to the chair and vice chair) nine members from academic institutions, ten patient advocates, four members from research institutions, and four industry representatives. The IP rules were researched and debated by the ICOC over more than two years, first for nonprofits and then for private corporations, and were finally ratified by the full board in March.

Biotech companies wanted to see the California rules mimic the 1980 federal Bayh-Dole Act that gave industry the right to the IP generated by government-funded research on very generous terms. That law ended royalty requirements and granted wide market rights to grantees in the commercial sector to speed drugs to market.

But the ICOC board members quickly made it clear that the Bayh-Dole "free money" model was not going to be replicated, says Klein. "The federal position is a nonstarter in the states," he says. "Taxpayers and businesses want to see some specific financial return for the state." California will only give grants for research done in California, and grantees are strongly urged to use California suppliers. Consumer advocates argued that patents resulting from CIRM grants should be held by the state. "IP policy is the one place where you can demand to make results of research affordable and available to people funding it," says John Simpson, director of Consumer Watchdog (formerly the Foundation for Taxpayer and Consumer Rights), which has received grants from the Nathan Cummings Foundation specifically to monitor California’s stem cell agency. "We see IP as a lever that the state can use to bring about more responsible behavior on the part of the companies."

At the end of the long process, both consumer and industry groups say that the committee split it more or less down the middle-nobody got everything they wanted.

"The people I have talked to say it’s a relatively fair solution to a very complex problem," says Jimmy Jackson, public policy director of Biocom, a California life science industry trade group. "I don’t know of anyone who got everything they wanted out of this."

The present guidelines say that patents will belong to the companies whose employees did the research. But if a company licenses state-funded research to another company, the state gets a quarter of the royalties. Companies that commercialize state-funded discoveries themselves must pay royalties of up to 5 percent until they’ve paid back their grant three times over. Additional "blockbuster" payments are required for drugs discovered with state funds that generate more than $250 million of revenue annually. What’s more, CIRM-funded inventions will have to be sold at mandated low prices to California’s discount prescription drug programs for the state’s poor.

But even now, the rules seem to be in flux. The CIRM board is considering changes in the regulation that would expand the in-state discount to inventions that even got a small amount of CIRM research money. And a bill
sponsored by state senator Sheila Kuehl, D-Los Angeles, would make some of the IP requirements state law, instead of board regulations. She wants to make sure that companies have to go to the legislature for any policy changes, rather than the ICOC, where the majority of board members are affiliated with the grant-seeking institutions.

These moves are just what worry companies, says Paul De Stefano, a Fish & Richardson partner and former chief corporate counsel for Genentech Inc. Experience shows, he says, that severe IP requirements can discourage many companies from applying for any money at all, pointing to foundations like the Gates Foundation that require grantees to publish discovery data and make it widely available in the developing world. Through the Bayh-Dole Act, the federal government retains march-in rights-in an emergency, the government can force compulsory licensing-but they’ve never been used. By contrast, California’s stem cell agency is still an unknown quantity, and that spooks the biotech industry. "There is an oft-repeated concern that IP will need to be shared with competitors," says De Stefano. "Whether that’s a
legitimate fear or not, I’ve heard literally dozens of investors talk about it," he adds.

BioTime Inc., for instance, had considered applying for a small CIRM grant – only about $300,000 – but has decided to look elsewhere for now. The company’s CEO, Michael West, says he still might apply for a CIRM grant, but he’ll keep the money away from BioTime’s core business so as not to burden the company with what he calls "completely unrealistic" state royalty rates. "People don’t realize this really is a cottage industry," says West, who moved his company to California from Western Massachusetts after Proposition 71 passed. Still, West is hesitant to criticize CIRM or Proposition 71. "I’m proud of California," he says. (West, a cofounder of stem cell pioneer Geron Corporation, was CEO of Advanced Cell Technologies in 2001, and saw $20 million in financing evaporate the day Bush announced the new research restrictions.) Whatever strings are attached to state money, he says, the passage of Proposition 71 at least reassured venture capitalists that the stem cell industry wasn’t going to wither away because of Bush’s policies-and that’s been a real boon for business.

The fact that CIRM is considering changes to the IP policies is "disquieting, to say the least," says Palo Alto-based StemCells, Inc. general counsel Kenneth Stratton. His company, which along with Geron is well-established by industry standards, won’t say whether it is applying for a CIRM grant. But like West at BioTime, Stratton says that the requirements make CIRM money expensive and less attractive than other options. The agency is at risk of becoming a "funder of last resort," says Stratton. "The whole point of Proposition 71 was to give away the money to the people and
companies that can most use it, those that are struggling because of federal restrictions on stem cell research." But the public access requirements are completely unpredictable, says Stratton. "We will take CIRM money last. We don’t want to be in a position where, years from now, we are actually forced to sell [our products] in California at a loss."

Still, with the first tranche of $25 million in for-profit grants ready to be dispensed from the CIRM pot, companies are lining up to apply despite their doubts. CIRM officials are reviewing 50 grant applications from for-profit companies right now and are expected to reveal who made it to the second round this month. To the critics of ICOC policies, CIRM lawyer Scott Tocher says that the number of for-profit applicants proves that its rules aren’t too onerous.

Meanwhile, similar debates are taking place in other states that have decided to increase their funding of biomedical research. Connecticut, New York, Wisconsin and New Jersey have all committed state money [see page 36], but haven’t gotten into the nitty-gritty of IP rights yet. Connecticut is pursuing a model where it lets companies applying for grants propose their own royalty rates, with a 5 percent minimum. In New York, the state’s Department of Health is weighing its options, but has thus far chosen to write IP requirements into each grantee’s contract rather than set regulations or statutes. Massachusetts’s legislature is presently considering a $1 billion stem cell spending bill that would make it the
second-largest after California. (Says partner Patrick Waller of Boston-based Wolf Greenfield & Sacks: "Politically, the bill was partly in  response to the California initiative-for our state to be seen as doing something to promote or maintain biotech strength in Massachusetts.") Even though embryonic stem cell research is favored by a solid majority of voters, it’s not always winning votes. In November, New Jersey voters shot down a proposal to spend another $450 million on stem cell research, a loss that patient advocates attribute to a low-turnout election, a highly motivated right-wing religious opposition, and a $3 billion state budget shortfall.

Bob Klein likes to remind his audiences that California is a bioscience powerhouse-for instance, nearly 40% of the market value of all Nasdaq-listed life sciences companies rests in the state. As the research funded by Proposition 71 – with any luck-leaves the lab for human trials, IP experts and average taxpayers in other states – and quite possibly other countries – are going to take a hard look at the state’s patent policies. Their reactions will determine whether, over the long run, the state that Klein calls the "rebel territories along the coast" is driving down the middle of the road, or is way out on a limb.

States that plan to spend funds* on stem cell research over the next decade:

California: $3 billion
Massachusetts: $1 billion (bill expected to pass soon)
Wisconsin: $750 million (public and private money)
New York: $600 million
New Jersey: $270 million
Connecticut: $100 million

*of more than $100 million