Updated from 7:16 a.m. EST

ImClone Systems

(IMCL)

, hammered for months after a rejection by federal regulators set off an insider trading scandal, may be facing another setback for its make-or-break cancer drug, Erbitux.

ImClone shares have lost 85% of their value since Dec. 28, when the Food and Drug Administration

rejected the company's application for Erbitux, chiding the biotech for sloppy work that obscured the drug's efficacy. That ruling set off a cascade of damaging disclosures that forced former ImClone CEO Sam Waksal to plead guilty to some charges of insider trading on Oct. 15, and have ensnared lifestyle guru Martha Stewart, a Waksal friend, in the controversy over her sales of ImClone stock.

Now, the European clinical trial of Erbitux that ImClone has counted on may have failed, according to two sources who have been in contact with European doctors participating in the study. The study, conducted by ImClone's German partner,

Merck KGaA

, is largely complete, save for a final audit of data, and the negative results, albeit preliminary, are not likely to change, these sources say.

Merck strongly denies that its Erbitux trial is running into trouble. "This is definitely not true," says Dr. Bernhard Ehmer, Merck's head of oncology. "The clinical data cutoff for the study is at the end of the year, but an analysis won't be completed until the first quarter of 2003."

ImClone's Trials
Erbitux efficacy questioned

As part of its Oct. 24 release of third-quarter results, Merck CEO Bernhard Scheuble reiterated strong support for Erbitux. "With months of negative news swirling around

Erbitux and our U.S. clinical partner, I want to emphasize that Merck remains fully committed to this drug. Our phase III clinical trial remains on track and data analysis is expected in the first quarter. We plan to file our European application in the second quarter."

ImClone issued its own statement Tuesday. "As our partner Merck KGaA has said, the information in this story is premised solely on unsubstantiated rumor. Merck KGaA has said that the clinical data cutoff for the study is at the end of the year and data analysis is expected in the first quarter of 2003. Accordingly, any speculation about the results of the data at this time is both premature and irresponsible."

Imclone shares were off 9% to $7.27 in recent Tuesday trading.

ImClone has been counting on positive results from the Merck study to bolster its own suspect data collected on Erbitux, which would have allowed the company to once again submit the colon cancer drug to the FDA for review. The most optimistic estimates had ImClone pushing Erbitux back to the FDA early next year.

Without strong European data, FDA officials are likely to tell ImClone to wait for the completion of new, ongoing U.S. studies before resubmitting Erbitux for review. At least one of these studies started only in August.

But

TheStreet.com

has spoken to two separate sources, both of whom have European investigator contacts with knowledge of preliminary results from the study. The preliminary results show that Erbitux was not effective in boosting the response rates of colon cancer patients enrolled in the study.

One source who spoke to

TheStreet

is a U.S.-based oncologist, specializing in colon cancer, with no investment position in ImClone or Merck. The other source is a Wall Street fund manager who has been long ImClone in recent months. Both sources requested anonymity.

Last December, the FDA refused to accept ImClone's application for Erbitux, chastising the company for sloppy clinical work that made it impossible to determine the drug's efficacy in patients with advanced colon cancer. ImClone claimed that Erbitux, when given alongside the chemo drug, irinotecan, shrunk tumors in 22.5% of patients.

But after these results were re-examined by researchers at

Bristol-Myers Squibb

(BMY) - Get Report

, ImClone's partner, the response rate was reduced to 12.5%, a level unacceptable for FDA approval, according to testimony offered at a recent congressional hearing into the matter.

The FDA's refuse-to-file letter of Dec. 28 sent ImClone's shares tumbling and set off a series of revelations that placed the company's name in the corporate rogues gallery alongside the likes of

Enron

,

WorldCom

,

Tyco

and

Adelphia Communications

. On Dec. 28, ImClone was trading at $55 per share; the stock closed Monday at $8.01.

But all the sensational ImClone headlines are merely a distracting sideshow to the only question that really matters to the company's investors, and more importantly, cancer patients: Is Erbitux a real drug? And if so, when will it be approved? Supporters were hoping that the European data being compiled by Merck would be the thing to erase the painful sting of the past year.

Merck is a German drugmaker, unaffiliated with the U.S. pharmaceutical firm of the same name, which is in charge of developing Erbitux for the European market. As part of these efforts, Merck has completed a 330-patient study that tests Erbitux, by itself, against a combination of Erbitux and irinotecan.

Last February, with ImClone seeking ways to salvage its plan for Erbitux, the company convinced the FDA to

consider results from the Merck study as a way to get the drug approved here. The design of this trial is especially important because it satisfies one of the FDA's major concerns with the way ImClone conducted its own trials. A successful outcome would increase the odds of Erbitux winning approval in the U.S. and Europe.

But if the Merck trial fails, as sources tell

TheStreet

, ImClone will be forced to fall back on alternative plans to get Erbitux approved. The company, along with partner Bristol-Myers, already has started enrollment in a new clinical trial that will test Erbitux as a stand-alone treatment for 250 patients with advanced colon cancer.

At the annual meeting of the American Society of Clinical Oncology last May, ImClone reported results from a small, 57-patient study using Erbitux as monotherapy. In that study, tumors in six of 57 patients, or 10.5%, shrank by at least half, the company said. The new Erbitux monotherapy study, which began in August, will attempt to confirm, or improve upon, these results.

If ImClone and Bristol-Myers try to get Erbitux approved as a stand-alone cancer drug, it will be following in the regulatory footsteps blazed by

AstraZeneca

(AZN) - Get Report

and its similar, targeted cancer drug, Iressa. On Sept. 24, an FDA advisory panel recommended Iressa's

approval as a stand-alone treatment for advanced lung cancer, based on data showing the drug shrank tumors in 11% of patients. The positive nod was granted despite other studies in which Iressa failed to show any efficacy when used in combination with existing chemotherapy drugs. The FDA has yet to make a final decision on Iressa's approval.

ImClone long maintained that Erbitux worked only in combination with other chemotherapy drugs. In fact, the company chose to ignore FDA advice to pursue approval as a single-agent treatment, usually a less-risky regulatory approach.

ImClone has confirmed the start of the 250-patient monotherapy trial to bolster the findings presented at ASCO, for Erbitux, but has not offered any details. According to a study protocol found on the National Institute of Health's Web site, the new study is being conducted at four hospitals in Florida, Georgia, New York and Texas.

Colon cancer patients eligible for the trial will be given Erbitux only after failing at least two prior rounds of chemotherapy treatment, including the use of oxaliplatin, which was only approved for use in the U.S. in September. This could slow the study's enrollment because finding patients quickly who don't respond to oxaliplatin could be difficult, given that the drug is just making its way into the colon cancer-treatment repertoire.

ImClone and Bristol-Myers also could decide to ditch Erbitux as a colon cancer treatment, and concentrate instead on getting the drug approved for patients with head and neck cancer. Although earlier studies in head and neck cancer have proven disappointing, the company is conducting another, larger study testing the drug in combination with radiation. Results are expected next year.