Armed with research on drug patents and a spate of internal emails from the United States Patent and Trademark Office, hedge fund manager Kyle Bass attacks pharma regulation.

The arthritis drug Vimovo is actually a combination of two existing drugs, a pain reliever called naproxen and a heartburn drug called esomeprazole magnesium (Nexium). Because taking nonsteroidal anti-inflammatory drugs like naproxen can cause heartburn, the two are sometimes taken together. Both drugs have cheaper generic versions, and are sold over the counter. They have existed for decades and, if sold separately, would cost patients 80 cents per day. Vimovo, on the other hand, is a branded, patent-protected “combination drug,” and needs to be prescribed by a doctor. Its cost to patients is more than $52 per day—66 times that of the two drugs it contains.

The U.S. rights to Vimovo were acquired by Horizon Pharmafrom AstraZeneca in 2013. Horizon is also the manufacturer of a similar drug called Duexis. Since it bought the rights to Vimovo, Horizon has hiked the price of the drug by more than 600 percent. The drug’s annual sales, according to Horizon, increased from $20 million under AstraZeneca to $163 million in 2014, a figure that represents more than 50 percent of Horizon’s overall annual sales. 

In 2015, Texan hedge fund manager Kyle Bass, who made a fortune when his hedge fund Hayman Capital Management shorted the subprime mortgage market prior to the housing market crash, started challenging the patents on drugs like Vimovo. He created an organization called the Coalition for Affordable Drugs and raised nearly $1 billion to pursue an investment strategy that targeted what he regards as abusive patents that artificially drive up prescription drug prices.

The opportunity presented itself in the form of the America Invents Act (AIA), signed into law by President Barack Obama in 2011. The America Invents Act created a process known as inter partes review, or IPR, which allows anyone to challenge the validity of patents by filing a petition to the United States Patent and Trademark Office (USPTO). The procedure, originally created to help tech companies deal with so-called “patent trolls,” is carried out by the Patent Trial and Appeal Board (PTAB), an administrative arm of the USPTO that was formed in 2012 as part of the AIA. It is much cheaper than challenging a patent through the federal courts.

In January, Bass visited the Stigler Center as a guest speaker. Bass explained the procedure: “This process is so clear. It’s an 18-month statutory process. You file a challenge, they [pharmaceutical companies] have to respond in writing within ninety days, then the court decides whether or not it’s going to hear the case. Then, within a year from that day, they have to give a formal written opinion. It costs about $1 million per filing. It’s easy.”

At first, the IPR part of his strategy looked to Bass like a sure-fire thing: you scour the FDA’s Orange Book, find the worst examples of “evergreening,” the process through which drug companies artificially extend patents that are about to expire, challenge the patent by filing an IPR, and then short the stock of the pharmaceutical company that manufactures it. To do that, Bass partnered up with Erich Spangenberg, who some tech firms consider to be the original “patent troll.” Spangenberg became the scourge of Silicon Valley by purchasing technology patents and then suing tech companies like Apple for allegedly infringing them.

“We invest in companies that we think have strong intellectual property and we invest against companies we think have weak intellectual property,” Bass told The Wall Street Journal in 2015.

At first, Bass expected the process to be relatively easy. According to a study published in the University of Chicago Law Review in 2014, 77 percent of the patents that were reviewed through the IPR process have been invalidated or disclaimed. The process is so effective, that Randall Rader, former Chief Judge of the United States Court of Appeals for the Federal Circuit, once accused PTAB judges of “acting as death squads, kind of killing property rights.”  Out of more than 3,500 drugs and 11,000 patents in the FDA’s Orange Book, Bass only intends to challenge less than 1 percent. Hayman used an algorithm to locate the worst ones.

The effort turned out be much harder than he initially expected. Since February 2015, Bass has filed 37 challenges. (The petitions cover 14 companies and 15 drugs.) Out of 16 challenges that have been decided already, only 44 percent were instituted, a significantly lower “batting average” than he imagined, especially since, he says, the patents he chose to go after were “truly egregious examples” of patent abuse.

Diprivan, for instance, marketed by Fresenius Kabi, is actually Propofol, one of the most commonly used anesthetics in the world. A World Health Organization “essential medicine,” it has been known for decades and used in the vast majority of surgeries in the United States. The only patent protecting it from a potential 90 percent price-cut has nothing to do with its chemical composition but with its packaging: the patent covers only the siliconized rubber stopper that is found on the containers and vials that contain the drug.

(A spokesperson for Fresenius Kabi said: “we believe in our intellectual property and will always defend it to the fullest extent. Packaging is important, particularly for a drug like Diprivan, which is an emulsion. This is also currently an affordable product. There is generic competition. The cost per dose of Diprivan is 12 cent per milliliter, which is incredibly high value for a drug that’s used 50 million times per year in the U.S. alone.”)

Another patent targeted by Bass is the one that protects Suprenza, a weight-loss drug marketed by Citius Pharmaceuticals. This time, the patent covers the blue bits of soluble sugar that give the drug its novelty “speckled appearance.” “I guess no one in the patent office has ever chewed Tutti Frutti gum,” said Bass, “and so they didn’t know the prior art on this goes back sixty to seventy years.”

“You can’t believe how bad these patents are. How stupid they are. You can’t believe the Patent Office actually granted it as a novelty, and yet they stand. The intellectual property foundation of pharma allows these monopolies to charge whatever they want to charge,” he said.

To Bass, this was an effort with an enormous added social value: Americans spend more on health care than any other country in the Organization for Economic Cooperation and Development (OECD). Prescription drugs are a big part of that: according to the Federal Trade Commission, in 2014 brand-name drugs accounted for just 12 percent of prescriptions, but 72 percent of total consumer spending on prescription drugs ($374 billion).

Pharmaceutical companies often justify frequent price increases and extended patent protections by saying they need to cover the high cost of R&D, but R&D spending has been essentially flat since 2007, hovering around $140 billion. As a share of their revenues, it dropped from 18 percent to 13 percent.

Often, Americans pay much more for the same prescription drugs than people in other countries. The anti-leukemia drug Gleevec, for instance, was sold for $6,214 in the U.S. in 2013, and $1,141 in Canada, according to the latest comparative price report from the International Federation of Health Plans. Multiple sclerosis drug Copaxone was sold at the time for $3,903 in the U.S., compared with $862 in England.

“We basically subsidize the rest of the world. They get the same drugs at much lower prices from our companies,” said Bass.

In the U.S., drug patents last for 20 years from the date of filing. (Drugs are often protected by multiple patents.) Drug companies, however, utilize a number of methods to extend patents and maintain monopolies, by preventing generic manufacturers from entering the market. One of these tactics is called “evergreening,” or “lifecycle management,” a practice in which patent protections are artificially extended through minor tweaks, such as new dosages or formulations (for instance, creating extended-release versions of existing drugs). The process of making minor alterations that have no therapeutic benefits in order to preserve monopoly profits is also sometimes referred to as “product hopping”: after tweaking the existing formulation of the drug, the companies often drastically limit the supply of the older version, in order to ensure that doctors prescribe the new version.

Other ways to prevent generics from reducing branded drug prices include tactics like “no-authorized-generic,” when a manufacturer of a brand-name drug agrees not to market a generic version of its own once the first generic option is released; and the use of safety guidelines known as REMS as an excuse not to provide generic companies with samples of branded drugs.

Another legal tactic to keep drug prices up is called “pay for delay,” or reverse payment patent settlements. When the patent on a branded drug is about to expire, generic manufacturers looking to release their own versions file a challenge on the patent. In order to protect their patent, pharmaceutical companies pay the generic manufacturers handsomely to delay the introduction of competition to the market. Even after a generic enters the market, there will often be an extended period of time where it is the only generic choice. Essentially, these settlements protect monopoly profits, by allowing branded and generic manufacturers to “share the wealth.”

In 1984, Congress passed the Hatch-Waxman Act, a bill that was meant to balance the need to keep patent protections in order to encourage innovation among pharmaceuticals with the need to encourage generic manufacturers to enter the market more quickly. In many ways, the bill was a success — the number of generic drugs in the market has increased dramatically since 1984 — but one of its unintended consequences was that it also made “pay for delay” common practice. According to the FTC, which has stepped up efforts to curb the practice in recent years, these deals cost consumers and taxpayers $3.5 billion per year. In 2013, the U.S. Supreme Court ruled that “pay for delay” deals could be in violation of antitrust law in some cases, and allowed the FTC to sue pharmaceutical companies on these grounds.

Since then, according to a recent report by the FTC, “pay for delay” schemes fell sharply. The number of deals has dropped to 21 in fiscal 2014, compared with 29 deals in 2013 and 40 in 2012. Last year, Senators Amy Klobuchar (D-Minnesota) and Charles E. Grassley (R-Iowa) reintroduced a bill that would make “pay for delay” illegal. Last May, the FTC announced that Teva Pharmaceuticals will pay $1.2 billion to settle charges that one of its subsidiaries, Cephalon, paid several generic firms more than $300 million in order to delay the launch of cheap generic versions of its best-selling narcolepsy drug Provigil. It was the largest settlement of its kind.

Hayman, says Bass, will not settle with drug companies in order to drop its challenges.

While abuse of the patent system is hardly unique to the pharmaceutical industry, weak drug patents impose much-higher costs on taxpayers, consumers and the U.S. economy as a whole. Market monopolies in pharma are one of the main reasons why drug prices and health care costs in America are so steep, because they prevent generics from entering the market. “Once a drug has been around for twenty years, there is nothing tethering that drug price to anything—not inflation, not their own cost, not the cost of R&D—other than how high drug companies can raise it and what Medicare will pay for,” said Bass.

If one generic enters the market, though, the effects are swift and dramatic: the average price drops by 6 percent. If two generics enter the market, the price drops by 58 percent. If a market has 20 generics, the price drops by 94 percent. According to the FTC, generics saved consumers $239 billion in 2013 alone.

If he wins his challenges, said Bass, patents that cost consumers hundreds of millions of dollars each year will be invalidated, and generics will be allowed to enter the market, leading to a sharp drop in prices as a result. “If we win, everyone benefits but pharma: the government, taxpayers, consumers,” he said.

All the drugs whose patents Bass challenged represented the majority of their makers’ revenues. The first half of his strategy (investing against companies that have weak intellectual property) seemed simple: dispute the “ridiculous” patents that shouldn’t have been issued in the first place, short their stocks, and rake in the cash. 

But Bass didn’t factor in the scale of pharma’s regulatory capture. Even after his first three challenges were denied without being heard, Bass described his battle with Big Pharma as a “fun fight.” As he told CNBC’s David Faber in September, “We’re well funded and we have all the time in the world the way that we have set this up. And we want our challenges heard on the merits.”

Recently, he has returned most of the money he raised for his pharma vehicle: $700 million.  According to Bass, this is by no means a sign that he has given up. “There is zero give-up here. We have 100 percent of the capital needed to pursue every single challenge to its end,” he said. The money that was returned to investors, said Bass, is the money that was meant for short-selling pharmaceutical stocks, and it was returned to investors following a decision to not pursue a capital markets strategy for the moment, due to adverse market conditions.

After a year of exposure to the enormous scale of regulatory capture in the pharmaceutical industry, however, Bass sounds, in his own words: “really cynical and really negative.” 

“Fighting through what’s going on has been an epic David and Goliath battle, and it hasn’t been fun, to tell you the truth. They have so many people every single day on this and so many more resources than we do,” he said. “Pharma’s got the U.S. and the world captured.”

Thanks to a recent Freedom of Information Act request, Bass now claims he has evidence of what he described as far-reaching regulatory capture that prevents his cases from being heard.

“Drug companies are more profitable than Google”

Bass’s Hayman Capital Management has raised close to $1 billion for its pharmaceutical effort, but it is no rival for Big Pharma’s political might. Since 1998, pharmaceutical companies have spent nearly $3 billion on lobbying, more than oil and gas companies, the auto sector, and real estate companies spent on lobbying during this period combined. The industry hired more than 1,300 registered lobbyists in 2015, and is a major political contributor: in the 2012 election cycle alone drug companies made campaign contributions worth over $50 million, according to the website

When Bass made his first foray into the market, the industry was quick to respond. “They hired a hundred lobbyists, they tried to hire two of my lobbying friends,” he said. Industry spokespeople and U.S. senators claimed his challenges should be thrown out because he has a “profit motive.”

In July 2015, Celgene, manufacturer of the multiple myeloma drug Revlimid, filed a motion to sanction Bass’s Coalition for Affordable Drugs for allegedly “abusing” the IPR process in order to generate profits. PTAB judges, however, dismissed the motion and acknowledged in their ruling that “profit is at the heart of nearly every patent and nearly every inter partes review.” The panel also ruled that Bass’ short-selling strategy is “legal and regulated.”

Drug companies also lobbied hard for an amendment to the America Invents Act, proposed in the Senate Judiciary Committee by Senator Thom Tillis (R-NC), that would have made it impossible to file an IPR claim on pharmaceutical and biological patents. But in July, the Center for Economic and Policy Research (CEPR) published a report that estimated the cost of exempting drug patents from the IPR process at $31-$93 billion, and a month later a separate Congressional Budget Office analysis estimated the exemption would add $1.3 billion over a decade to the cost of federal health care programs. Shortly thereafter, the amendment was scrapped.

While the Senate Judiciary Committee was still debating whether to exempt drug companies from the IPR process, AARP and a number of other organizations – among them the Blue Cross Blue Shield Association – sent a letter beseeching it to scrap the amendment. The IPR process, the letter said, “is a critical consumer protection against abusive patent extensions that limit patient access to more affordable treatment options, delay market entry of less expensive generic therapies, and drive up drug costs.” Exempting drug companies and biotech firms, the letter said, “is unwarranted and harmful to consumers.”

Pharma’s influence on American politics has always been far-reaching. One of the industry’s major victories has been Medicare Part D, Medicare’s prescription drug program. Signed into law by President George W. Bush in 2003 as part of the Medicare Modernization Act, Medicare Part D made it illegal for Medicare to negotiate cheaper drug prices. The result has been a steep price increase.

“Drug companies have more than ninety-five percent gross margins, and fifty-five percent net margins. They’re more profitable then Google on the net side, because they can charge whatever they want,” said Bass.

The Affordable Care Act, in its original conception, was supposed to make it legal again for Medicare to negotiate drug prices. As a presidential candidate, Barack Obama promised to end the prohibition. Eventually, though, the Obama administration had to cut a deal with drug companies that extended Medicare Part D in order to get the support of the pharmaceutical industry that was seen as crucial to getting Obama’s health care overhaul passed. Drug companies agreed to commit $80 billion towards Obamacare, in the form of discounts for seniors, and the White House agreed to ease up on its intention to allow Medicare to negotiate for lower drug prices.

“Capture happens at the highest levels of our democracy,” said Bass. “It happens at the presidential level, and trickles down from there. And I can talk about which senators and congressmen are bought and paid for by pharma, because it’s almost all of them.”

During his crusade against abusive pharmaceutical patents, Bass has been targeted by a number of senators and congressmen from states that host corporate pharmaceutical headquarters, among them Senator Bob Menendez (D-New Jersey) and Senator Chris Coons (D-Delaware).

But pharma’s influence goes beyond Capitol Hill and extends deep into the USPTO, he claims. “All I’m doing is filing a challenge and asking an administrative law board to decide whether or not that patent should exist,” says Bass about the PTAB. “They are supposed to be an umpire. Their only job is to call a ball or a strike. But they’re not doing anything like that. Pharma’s got them captured too.”

The USPTO, claims Bass, maintains a warm relationship with pharmaceutical companies. He points to instances of revolving-door among patent officials: Janet Gongola, the USPTO’s patent reform coordinator, previously worked as a patent attorney at Eli Lilly. Philip Johnson, who was one of the White House’s leading candidates to lead the USPTO, was a longtime pharmaceutical executive.

From the beginning, Bass says, his challenges were met with extreme difficulties. IPR filings usually have a high rate of institution, but when it comes to his challenges, less than 50 percent have been accepted for review. “They are holding us to a higher standard,” he said. “We think the fix is in.”

As an example, he notes his IPR filing against a MS drug named Tecfidera, manufactured by Biogen. “Tecfidera was the one we thought was a slam dunk. I would have bet the whole fund on this one – I’m glad I didn’t,” he said. The reason for the optimism was that Bass’ Coalition for Affordable Drugs found what it thought was a more than enough reason to invalidate Biogen’s patent on Tecfidera, which covered the drug’s dosing regimen: a description of a previous Phase II clinical trial, which it submitted as “prior art” (evidence that an invention was known before it was patented – and therefore its patent is not valid). However, despite former precedents that deemed phase II clinical trials as prior art, the PTAB panel rejected Bass’ challenge without a formal review.

The Tecfidera loss was the one that really caught Bass by surprise. In interviews with Bloomberg and Business Insider soon after, he blamed USPTO director Michelle Lee of “running a kangaroo court.” Ironically, prior to joining the USPTO, Michelle Lee worked at Google as deputy general counsel and as the company’s head of patents. During her time at Google, the company lobbied for the America Invents Act, the same law that allows Bass to file his IPR challenges.

The main piece of evidence supporting Bass’s claims of regulatory capture comes in the form of internal PTAB emails, recently obtained through a FOIA request. According to him, they show there’s a strong pro-pharma bias within the USPTO.

One email, for instance, discusses a meeting between Michelle Lee and top officials from BIO, the lobbying group of the biotech industry, including president and CEO of BIO James C. Greenwood. In advance of the meeting, held in February 25, 2015, shortly after Bass began to file his challenges, she is seen receiving a file attachment that bears Bass’s name and another file named “PTABonBogusPetitions.” According to Bass, Lee has avoided meeting with him so far, despite his repeated requests. The USPTO has so far refused to reveal to Bass the content of these files, despite the FOIA request. Bass says he intends to file another FOIA request in order to receive the files.

In another email that discusses a “patent litigation task force meeting,” Alan Marco, the USPTO’s chief economist, is referring to “event studies” that, he writes, “look at stock market reactions to the Kyle Bass petitions.” “Their sole role is to call balls and strikes. So why do they have their chief economist study the potential market impact of us winning? That’s not their job. Their job is to follow the law as its legislated,” said Bass.

Several emails show USPTO and PTAB officials circulating news articles about Bass’s cases. Most of their comments on these stories have been redacted. “The entire PTAB was circulating my batting average,” says Bass. “Why do they care? They’re supposed to judge every case based on its merit.”

Overall, he says, Hayman received 611 pages of emails, and “they show the PTAB rooting against us.”

Regulatory capture, claims Bass, is so massive when it comes to pharmaceuticals that it got even to the “one place I never thought there would be capture”—the administrative law judges at the USPTO.

“I never thought they would be captured,” he said. “I assumed they would think this is a bit fun, an underdog coming in and knocking some of these shitty patents. But several administrative law judges who had been in some of our panels now work for pharma at some of their best outside law firms. I guess they kind of got a reward for turning us down. They’re all lawyers, and they can earn much more money working for the big law firms. This is the kind of capture I never expected going in.”

“I know it sounds conspiratorial,” he said, “but it’s a fact.”

Paul Fucito, the USPTO’s press secretary, said: “The PTAB judges base all of their decisions on each case they hear solely upon the facts and law as it applies to each particular case. The PTAB trial proceedings were created by Congress in the America Invents Act. The USPTO is faithfully implementing them according to law, adhering to the statutory framework and to all rules of evidence and procedure.”

Horizon Pharma declined to comment for this article. Celgene, Biogen, Citius and BIO did not respond to requests for comment.

“I’m Surprised I Didn’t Hire Martin Shkreli”

In September, a pharmaceutical company named Turing Pharmaceuticals hiked the price of a toxoplasmosis drug called Daraprim, a specialty drug whose patent expired in 1953, by more than 5,000 percent – from $13.5 to $750 per pill. It had acquired the drug only a month earlier. The move prompted widespread public outrage. The company’s then-CEO Martin Shkreli, who vehemently defended the price hike despite allegations of price gouging, became an instant celebrity and was vilified by media outlets and politicians as the public face of a broken system that allows blatant manifestations of greed. (Turing later reduced its price hike by 50 percent, but the price reduction did little to restore the company’s image.)

Following Shkreli’s price hike, and after dozens of similar price hikes by companies like Valeant were exposed and caused a scandal, prescription drug prices became a hot-button issue in the media and among legislators, and a major theme in the 2016 presidential election. Democratic candidates Bernie Sanders and Hillary Clinton have both vowed to reduce the prices of prescription drugs. Both have released plans that would prohibit “pay for delay” schemes, allow Americans to import drugs from countries like Canada, and (in Clinton’s case) force drug companies that receive government support to invest in R&D.

As a result of newfound scrutiny, biotech stocks have taken a big hit, with the Nasdaq Biotechnology Index down 21 percent over a three-month period and nearly 24 percent since the start of the year. Bass, however, is not celebrating. “There’s a misconception that we only shorted stocks, but we went long and short. We went long on companies with strong intellectual property and short on companies with bad intellectual property. And we’ve been flat all along.”

The Shkreli scandal, he said, has been a huge boost to his cause. “The greatest thing that ever happened to the consumer. I’m surprised I didn’t hire him to do that – I was upset I didn’t think of that first. That brought the spotlight from Hillary Clinton and others to the space that we had been trying to bring the spotlight to.”

Bass, however, does not sound too optimistic about the chances of affecting change. “The system is rigged, and you can hear from my voice that it’s going to stay rigged,” he said. “We’re still going to win a few of these things, and still make some decent money. They need to approve a few [of our challenges] for political cover. I’m just disappointed. I thought our batting average should have been way higher than it is today, given the challenges we’re filing.”

What he hopes for, he said, is that non-profits or law schools will take up the cause and file IPR challenges against a drug patent. “Just to change the narrative. Make it not about hedge fund versus pharma,” he said. “They’ll think twice about turning down those petitions. They don’t think twice about turning mine down.”