The FDA has been playing a rough game of "Whack-A-Mole" lately, smacking down would-be drugs in the fields of obesity, diabetes and psychiatry, and hitting the stocks of companies like VIVUS (Nasdaq:VVUS), Arena Pharmaceuticals (Nasdaq:ARNA) and Alexza (Nasdaq:ALXA). With a very aggressive pre-panel meeting review, investors are now extremely nervous that the agency is about to do the same to MELA Sciences (Nasdaq:MELA) and MelaFind, the company's would-be testing device for melanoma (a very serious type of skin cancer).

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A Consummate Binary Event
For investors who are not familiar with the term "binary event", the FDA's ultimate decision on MelaFind is a very good working definition. While large medical device companies like Stryker (NYSE:SYK) or Medtronic (NYSE:MDT) need FDA cooperation to thrive, it is more of a matter of survival for MELA Sciences.

If the agency grants approval, the company will be able to enter a large field with no other comparable competitive device option. If the agency refuses to allow MELA to market this device, the company has nothing else in its bag and will effectively be a zombie company. In other words, the stock will go up a lot if the FDA approves MelaFind, or down a lot if MelaFind is rejected. Not surprisingly, then, there has been a huge amount of stock shorting interest and option activity going into Thursday's panel meeting.

The Story So Far
The path to this FDA panel meeting has not been a smooth one. The FDA originally issued a non-approvable letter to the company back in March. After this letter, the company requested (and was granted) a panel meeting to present and discuss the data supporting this device.

Now, as part of the normal pre-meeting procedures, the FDA has posted its review of the device and it is not encouraging. It is not unusual for the FDA to play the role of devil's advocate in these reviews (in fact, it is really part of their job), but the review on MelaFind was unusually harsh. As part of the review, the FDA commented that the benefits of the device were unproven and that it had the potential to actually cause harm. Moreover, the FDA suggested that the company should do further studies to prove the efficacy and utility of the device. (For related reading, check out FDA Makes Intermune Sick.)

As that comment suggests, the data is what matters here. Unfortunately, the data is not exactly clear. Clinical studies of MelaFind have shown 98% sensitivity, and that is not too bad (though it does suggest that the device will miss about two of every 100 potentially cancerous lesions it scans). It is also worth noting that all lesions examined in the study were initially flagged as potentially cancerous, so bears have argued that the device already had a "positive bias" going for it. Moreover, trial data has shown a specificity of 9-10% and that could be problematic as well.

While the company has talked about MelaFind as a device that could increase the diagnostic confidence of dermatologists and lead to lower biopsy rates, that sort of specificity could actually lead to more biopsies. More biopsies are not necessarily a horrible thing (they are rarely painful or disfiguring and melanoma is not a disease to be trifled with), but docs could simply do more biopsies without the machine. Moreover, there was a 7% failure rate in one trial, meaning that 7% of the scans did not work for some reason. While that sounds more like a commercial issue than a regulatory problem, it is nevertheless more ammunition for a safety-obsessed FDA. (For related reading, see A Checklist For Successful Medical Technology Investment.)

The Bottom Line
It is difficult to recall the last medical device approval process that garnered so much controversy and attention, and this whole process has been strange. Here a company chose to raise money before a panel meeting (although there is an argument to be made that companies cannot always pick and choose the "when"), and the company has been rather aggressive in its rebuttals of the FDA's concerns. While that may seem like a normal human reaction for people who are committed to this device, the FDA can always punch back harder than any one company, so it may not be the best tactic. (For related reading, see FDA To Obesity Drugs: Drop Dead.)

For investors, there is almost nothing left to do but take a position (or step to the sideline) and wait for the FDA's verdict. Given the extreme conservatism of the FDA recently, it is hard to have confidence that the panel will be supportive of this device and that the FDA will grant approval. Nevertheless, the company still has a fighting chance and the large potential commercial opportunity of this device will no doubt have many investors hanging on to their shares and hoping for the best both during the panel and in the FDA's ultimate response.

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