Ethics: Carbollic Smokeball under the regulatory hammer

The Carbolic Smokeball Company launched a product that it claimed provided protection from and cure of many ailments. It produced posters and advertisements in newspapers, all making claims that were wildly excessive. A customer decided it was not true and sued. The court agreed that the claims were not true but that they were so outlandish that no sensible person would rely on them. The court said that the claims were "mere sales puff." And so for generations, companies have felt free to lie about their products and services.

The USA's SEC is calling time on the idea that companies can make whatever claim they like.

Elizabeth A. Dragon, the former Senior Vice President of Research and Development at Sequenom, Inc., made presentations to analysts and investors about her company's pre-natal test for Down's Syndrome. The SEC says that, on at least three occasions, she lied about the efficacy of the test. It says that she claimed that the test could predict whether a foetus had Down's Syndrome with almost 100 percent accuracy.

>>>> Financial Crime Forum: Market Abuse : Singapore : 21/22 July 2010 <<<<

The SEC says she knew that the test was "far less accurate" than she claimed. When Sequenom later announced that it was no longer relying on the data that Dragon presented and the test would not be launched as planned, the company's stock price fell by approximately 76 percent.

"Elizabeth Dragon knew the truth about Sequenom's Down's Syndrome test, yet she told the public it was a near-perfect success," said Rosalind Tyson, Director of the SEC's Los Angeles Office. "Her actions misled investors with exaggerated information about a significant new product that never materialized."

The SEC's complaint, filed in federal court in San Diego, alleges that Dragon presented materially misleading scientific data about Sequenom's prenatal screening test for Down's Syndrome. She falsely claimed that the test's highly accurate results were obtained on a "blinded" basis, meaning that scientists did not know whether the foetus had Down's Syndrome at the time they tested the maternal blood sample.

However, the SEC alleges that Dragon provided her scientists with the known outcomes of the samples, which allowed them to manipulate the data in order to produce more accurate results. Dragon falsified the number of samples allegedly tested by Sequenom and she lied about how well the test worked, claiming that it produced unambiguous results. In reality, the test results were often difficult to interpret, which is why she needed to "unblind" the known outcomes to her scientists.

Dragon has compromised the action on the basis that she neither admits nor denies the allegations and undertakes not to breach Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5. She has also consented to be barred from being an officer or director of a public company.

The Court is to decide on the financial penalty at a later date, which suggests that Dragon is "helping with enquiries" and that other actions are pending.

So, it seems that Carbolic Smokeball may still apply for lying to consumers but that it's not acceptable in relation to markets.