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Committees Hear Debate on IP, Royalties Under State's $3 Billion Stem Cell Initiative

[Quotes CGS's Jesse Reynolds]

by Joyce E. CutlerThe Bureau of National Affairs
November 2nd, 2005

Sen. Deborah Ortiz

Requiring royalties or returns to California on the voter-approved $3 billion life sciences research bond act may lead to higher costs and fewer willing partners, parties told a joint hearing of several state legislative committees Oct. 31.

The funding program developed under Proposition 71, endorsed by 60 percent of voters last November, has awarded a few research grants as its future and the state’s ability to sell bonds are tied up in constitutional challenges in court.

Initiative supporters now are backing off claims in a study they funded that concluded some $1 billion would be returned to the state in royalties if therapies developed with Prop. 71 funds were commercialized.

In addition, questions are being raised that requiring any returns to the state could jeopardize the tax-exempt status of bonds sold, meaning bonds issued to fund Prop. 71 research grants would have to carry a higher interest rate to attract investors and thus cost the state more money.

“My own position has been and continues to be that we need very clear and strong standards to ensure that the state’s interests are protected and that the state receives a meaningful economic return on its investment,” said state Sen. Deborah Ortiz (D). The testimony was received at a joint hearing of the state Senate Health Committee and Subcommittee on Stem Cell Research Oversight, both chaired by Ortiz, and the Assembly Health and Assembly Judiciary committees.

Tax Issues.

Requiring royalties may jeopardize the tax-exempt status of bonds sold to fund 90 percent of the awards under Prop. 71 because of federal tax code restrictions, said Juan Fernandez, public finance director with the state Treasurer’s office, which acts as agent for sale of state bonds.

Federal tax rules on bonds are “less than clear,” according to Perry Israel, an Orrick, Herrington & Sutcliffe partner and treasurer’s bond counsel. Prop. 71 raises novel intellectual property tax issues “which have never been addressed by the IRS.”

Further, Dan Carson, director of the health services section of the independent Legislative Analyst’s Office (LAO), said if bonds were taxable due to royalty arrangements, a 1 percent higher rate of return would add $690 million in costs in the life of the bonds, or about $23 million more in payments per year based on a 30-year time period.

The state has not yet requested a private letter ruling from the IRS about the tax issues, Fernandez said.

State Report.

Under Prop. 71, the Legislature cannot touch the initiative for three years and any actions require a 70 percent majority. A constitutional amendment (S.C.A. 13) proposed by Ortiz would set specific standards regarding conflicts of interest for members of the Prop. 71's Independent Citizen's Oversight Committee (ICOC) and California Institute for Regenerative Medicine (CIRM) staff, as well as members of working and advisory groups under CIRM. An initiative is the only way lawmakers can tackle the constitutional amendment created by Prop. 71, Ortiz said.

Lawmakers asked the California Council on Science and Technology (CCST) to study statewide IP policies in general and specifically Prop. 71. CCST’s draft report released in August concluded any state IP policy must be consistent with the federal Bayh-Dole Act, which leaves the royalties with the inventor and does not require returns to the funder.

Rebecca Eisenberg, a University of Michigan law professor, in testimony via telephone cautioned that the CCST report “reflects the interest invested in the status quo” that is imposed under Bayh-Dole.

Jesse Reynolds, Center for Genetics and Society biotechnology accountability project director, agreed, calling the CCST report an “echo chamber of enthusiasm for the status quo, that is the Bayh-Dole Act.”

CCST members include researchers, professors, attorneys, and corporate executives.

“This is not a report or council that’s accountable to taxpayers” but to science and business constituents, “not Californians as a whole,” said Jean Ross, executive director of the nonprofit California Budget Project.

Bayh-Dole or Bust?

Yet conditions specific to California grants, such as favoring California researchers, may scare off potential researchers or investors, speakers told the joint hearing.

“I would worry about making your funding unattractive,” Eisenberg said. “You’re not the only game in town, even though you’re a very generous sponsor of stem cell research.”

Bayh-Dole helped clarify IP ownership, a critical element “because to effectively transfer intellectual property, there has to be a high degree of clarity about who owns the invention and who has authorizations to license,” said Allen Bennett, associate vice chancellor for the University of California at Davis.

Bennett, co-chair of the CCST IP study group that produced the report, noted that 40 percent of all patents UC Davis receives generate revenues. LAO’s Carson said 70 percent of the $100 million in 2002 revenues UC received from its inventions were for life sciences creations.

Researchers are accustomed to Bayh-Dole, said Eisenberg. “You’re fighting against powerful currents if you’re trying to do something different,” she said.

While California is putting up $3 billion, industry is spending hundreds of millions of dollars getting treatments to market, said James Pooley, a partner with Milbank, Tweed, Hadley & McCloy in Palo Alto, Calif., and a CCST member.

“And let me just put it this way--if industry does not find competitive incentives to invest in CIRM research, it will simply invest elsewhere. IP policy must be sensitive to this reality,” Pooley said.

ICOC, created by Prop. 71 to award grants and oversee CIRM, expects its IP policy to be out by February, said Ed Penhoet, ICOC vice chair.

“Today I am here to listen,” said Penhoet, who co-founded Chiron Corp. “I am not here to offer any solutions to IP problems. Our task is to listen to a broad constituency of the public. We do not have a preformed opinion about which is the right way for us to go.”

Public Realities.

Outcomes promised Californians were the “foundational element of public support” for Prop. 71, Ross said. A poorly crafted IP policy could lead to erosion of public support. “Taxpayers shouldn’t be asked to pay twice,” he said.

Center for Genetics and Society’s Reynolds said statements after the election about Prop. 71 “feel like something of a bait and switch.”

Jerry Flanagan, with the Foundation for Taxpayer and Consumer Rights, argued that public control and oversight of IP is essential to crafting an effective state policy.

Ortiz suggested conditioning grants on ensuring public agencies and the poorest Californians receive a price cut on any therapies developed with Prop. 71 funds.

But Eisenberg said that “it is much easier to use intellectual property to increase prices than it is … to decrease prices.”

“What’s really hard to do is simultaneously use intellectual property to promote product development and reimburse the state and lower prices,” she said, adding that it “is not an easy fit in a business scheme.”

Challenge Pending.

All the discussion may be academic depending on the outcome of litigation pending in California Superior Court, Alameda County. A Nov. 17 hearing is scheduled on a dismissal motion by California Attorney General Bill Lockyer (D), research institutions, and patient advocacy groups to a challenge of Prop. 71 (People’s Advocate v. Independent Citizens’ Oversight Committee, Cal. Super. Ct., No. HG05206766, motion filed 10/12/05; 4 MRLR 787, 10/19/05).

Lockyer and the groups say the initiative has sufficient safeguards. The California Family Bioethics Council’s amended complaint challenges the funding of CIRM while the People’s Advocate lawsuit argues that CIRM operates outside of state management and control. The complaints have been consolidated.

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