Drugs are one of the few products that cannot be freely manufactured and marketed to the public. Indeed, they are heavily regulated by the Food and Drug Administration (FDA), whose standards are the most rigorous in the world. The clinical trials necessary to gain approval of an Investigative New Drug (IND) take many years and a substantial investment in cash, especially the larger-scale pivotal trials required to demonstrate that the drug candidate is safe and efficacious.

The investor in biotechnology stocks needs to understand the stages that are necessary to bring a drug to market, the financial costs involved, the risks and rewards of the investment.

The potential rewards of investing in the biotechnology industry are substantial. A single "hit"- a drug approved by the FDA- will make a company not only profitable, but will likely provide the money required to fund a pipeline of new drug candidates.

If the rewards are substantial, so are the risks. These risks are tied to the hurdle of moving a drug through clinical trials to win FDA approval.

There are a number of stages a company must master to bring a drug to market. First, a company must discover a drug candidate, a process that varies greatly with the individual company. Historically, pharmaceutical companies have relied upon some 500 targets for therapeutic drugs. Today, with the revolution in genomics, proteomics and bioinformation technology, biotechnology and pharmaceutical companies will have some 5,000 potential targets for drug intervention.

In the Preclinical stage, the drug candidate must be screened against an assay, a test to measure a biological response assumed to be predictive against particular disease targets. A lead compound, (or compounds) must be isolated, its structure determined (if possible), and its properties improved. The compound must be tested in the laboratory and in animal studies to assess safety and biological activity. Successful results in animal studies, however, does not imply that the drugs will work in humans.

Next, an Investigational New Drug (IND) is filed with the FDA to begin testing of the drug in humans. The IND must indicate the results of previous experiments, how, where and by whom the new studies will be conducted, the chemical structure of the compound, the method by which it is believed to work in the human body, any toxic effects of the compound found in the animal studies, and how the compound is manufactured. The IND must be reviewed and approved by an Institutional Review Board composed of physicians at the hospital(s) or clinic(s) where the proposed studies will be conducted. The IND becomes effective if the FDA does not reject it within 30 days.

The sponsor of an investigational drug is responsible for designing its clinical trials. The study must include a protocol, a formal written document that sets guidelines for the trial. It includes the background for the study and its objectives, the number of patients to be enrolled, criteria for eligibility and ineligibility, primary and secondary endpoints, and a method of measuring the endpoints set out in the protocol. In later trials, the protocol may also include a plan for interim analysis to decide on a strategy for stopping a study early if sufficiently strong evidence of a treatment difference becomes evident during the trial. The trial results should be applicable to the reference population from which the study subjects were drawn. Results of a study are considered statistically significant if there is less than a 5% probability of being due to chance (p=/>0.05).

Some general observations: The better a disease is understood, the more likely that preclinical testing, such as using an animal model predictive of the disease target, will produce significant data about the drug candidate. When other drugs are already approved for a given indication, the trials can often be designed to avoid potential problems. On the other hand, when the indication is complex or not well-understood, such as sepsis or wound healing- which have accounted for a significant number of early biotech clinical trial failures- there is greater uncertainty. Often, there are no good animal models available for preclinical testing. When dealing with indications that are known to produce a high placebo effect, such as Alzheimer's and depression, larger trials may be necessary to produce statistically significant results. It is important to emphasize that the purpose of a clinical trial is not to cure patients but to prove statistical significance to get FDA approval.

Clinical testing of experimental drugs is normally done in three phases.

Phase I is concerned with safety. In these pilot studies, the company learns qualitatively about the drug. It tries to learn three things: the best way to administer the drug; the dosage; and the patient population that can show the greatest statistical significance to get the drug approved. The drug is initially administered to a small number of healthy individuals or patients, who are usually paid for their participation, over a period of several months to a year. The drug is evaluated for its effect on the body-- how it is absorbed, metabolized, and excreted. The study will investigate side effects as the dosage is increased. When patients are used, the trial may give some indication about efficacy.

Companies often do more than one Phase I clinical trial if they want to segment the population, e.g., those who have different stages of the disease, or those who have failed existing treatment regimens.

About 70 percent of experimental drugs pass this initial phase of testing.

Once a drug has been shown to be safe, it must be tested for efficacy. Phase II clinical trials may take up to two years. In some cases they may be conducted concurrently with Phase I clinical trials. The trial should be designed by the company to provide a "proof of concept" for the drug. It is preferable to test the drug on a carefully chosen patient population. For example, a drug with the potential to treat a broad range of automimmune diseases may include a study of psoriasis since patients who have this disease are relatively healthy and the results will not be skewed by other physiological complications. Using the drug in several Phase II trials, each focusing on a different indication, can help a company select the best indication for the drug.

Phase II trials typically involve hundreds of volunteer patients with the targeted disease. They are designed to evaluate the effectiveness of the drug and to determine any side effects. Sometimes, a Phase IIa trial is undertaken to determine a proper dosage; if successful, they will be followed by a Phase IIb trial to determine efficacy.

The gold standard for clinical trials are randomized, double-blinded, placebo-controlled studies. Most Phase II studies are randomized trials, in which subjects are assigned to a test group on a random basis. One group will receive the drug being tested, while a control group will receive a placebo. Often these studies are "double-blinded," with neither the patients nor the investigators allowed to know who is getting the experimental drug.

Phase II clinical trials are a major stumbling block for most experimental drugs. Less than a third of experimental drugs successfully complete this phase. Many drugs that worked in the laboratory are found to be toxic or cause serious side effects at a dosage required to produce efficacy.

Phase II results should provide results on the optimal dosing regimen, side effects profile, and the patient population most likely to benefit in a statistically significant way from the drug candidate. These results will enable the company to design pivotal trials with the best chance of success.

Pivotal trials are usually Phase III clinical trials. Occasionally, when the data from a Phase II trial are considered exceptionally positive, a company may condict a Phase II/III trial which is designed to produce sufficient date for FDA approval.

In Phase III trials, the drug is tested upon several hundred to several thousand patients. Most phase III trials are randomized, double-blinded, placebo-controlled trials that typically last for several years. The goal of the study is to test if the investigational treatment is safer and more effective than the standard treatment. If there is no standard treatment, well-defined endpoints should be chosen to measure the treatment's safety and efficacy in the selected patient population. The drug may be tested in combination with standard treatment to see if can produce better results than standard treatment alone, including any adverse reactions.

Phase III studies provide the FDA with information on the drug's safety and efficacy, and the range of possible adverse reactions.

After a Phase III trial is completed, the company must analyze the data, and, if the data indicates that the drug is safe and effective, file a New Drug Application (NDA). In the case of a biotech drug, a Biologic License Application (BLA) is filed. The NDA or BLA must contain all of the information on the drug that the company has gathered to date, including data from the clinical trials. NDAs are often over 100,000 pages in length.

The NDA/BLA is first reviewed by an advisory committee, made up of experts in the field under review, which explores issues and questions about the trial results. The advisory committee makes a non-binding recommendation, which in most cases is followed by the FDA.

The average NDA review time for new drugs approved in 1997 was 17 months. The FDA offers several exemptions from the full rigors of clinical trials. Under the FDA Modernization Act of 1997, the FDA can designate a drug candidate as "fast tack" if it is intended for the treatment of a serious or life-threatening condition, and it it demonstrates the potential to address unmet medical needs for such conditions.

There are a number of ways that a company can qualify for a faster review time. The Pharmaceutical Drug User Fee Act provides for faster drug approval in exchange for a $100,000 user fee. Priority Review Status provides for FDA action within 180 days from the date of filing.

Orphan Drug designation is offered by the FDA for biologics and drugs that are used to treat medical conditions that affect 200,000 or fewer patients in the United States. The Orphan Drug Act provides for tax credits based upon clinical development costs, along with FDA assistance in guiding the drug through the regulatory approval process. Most importantly, companies are given market exclusivity for seven years from the drug's approval date. However, a drug the FDA considers clinically superior to or different from another approved orphan drug, even though for the same indication, is not barred from sale in the United States during the seven year exclusive marketing period.

If the FDA approves the NDA, the drug becomes available for physicians to prescribe. The company must continue to submit periodic reports to the FDA, including descriptions of any adverse reactions reported.

For certain drugs, the FDA may request additional studies (Phase IV) to evaluate long-term effects. Other Phase IV studies done for regulatory purposes include label expansion studies. These can be studies to increase the applicable age range of patients, to add information about special populations of patients, to allow use of the drug with other medications, etc.

New drugs take from five to twelve years from discovery to FDA approval, with a cost of $100 million to $500 million, or more. Only one percent of drugs that look promising in the laboratory reach human clinical trials, and less than 20% of the drugs tested in clinical trials receive FDA approval.

When a company undertakes larger-scale clinical trials, its "burn rate" accelerates sharply. Partnering with Big Pharma is a often a necessity for biotech companies, which must decide at what stage it is willing to enter a collaborative agreement, and for what price. Promising Phase II results will provide a company with the clout to enable it to find a collaborator who is willing and able to fund the considerable expense of large-scale clinical trials. While this collaboration comes at a price, it is often necessary for few biotech companies have the financial means to fund either the pivotal trials or the marketing of the successful drug candidate.

Failure to win FDA approval can be devastating to the company and the company's stock price. Disappointing results, including failure to gain FDA approval after Phase III clinical trials will often cause a company's stock to plummet more than 50%, especially if there are no other promising indications for the drug or other promising drugs in the company's pipeline. The stock of a company that reported disappointing late-stage clinical trial results has declined an average of around 35% the week following the announcement. It is far less costly to terminate the development of a drug in early trials than in pivotal trials.