<PAGE>
                                                                     Exhibit 4.2

                          VALERA PHARMACEUTICALS, INC.

              SECOND AMENDED AND RESTATED INVESTOR RIGHTS AGREEMENT

                                 AUGUST 16, 2004
<PAGE>
                                TABLE OF CONTENTS

<TABLE>
<CAPTION>
                                                                            PAGE
                                                                            ----
<S>         <C>                                                             <C>
SECTION 1   GENERAL......................................................     1
   1.1      Definitions..................................................     1
SECTION 2   RESTRICTIONS ON TRANSFER; REGISTRATION.......................     4
   2.1      Restrictions on Transfer.....................................     4
   2.2      Demand Registration..........................................     5
   2.3      Piggyback Registrations......................................     6
   2.4      Form S-2 and S-3 Registration................................     7
   2.5      Expenses of Registration.....................................     9
   2.6      Obligations of the Company...................................     9
   2.7      Termination of Registration Rights...........................    11
   2.8      Delay of Registration; Furnishing Information................    11
   2.9      Indemnification..............................................    11
   2.10     Assignment of Registration Rights............................    13
   2.11     Amendment of Registration Rights.............................    14
   2.12     Limitation on Subsequent Registration Rights.................    14
   2.13     "Market Stand-Off" Agreement.................................    14
   2.14     Agreement to Furnish Information.............................    14
   2.15     Rule 144 Reporting...........................................    15
SECTION 3   COVENANTS....................................................    15
   3.1      Basic Financial Information and Reporting....................    15
   3.2      Inspection Rights............................................    16
   3.3      Confidentiality of Records...................................    16
   3.4      Reservation of Common Stock..................................    16
   3.5      Stock Vesting................................................    17
   3.6      Special Relationships of Prospective Employees...............    17
   3.7      Directors' Liability and Indemnification.....................    17
   3.8      Reimbursement of Expenses....................................    17
   3.9      Qualified Small Business.....................................    17
   3.10     Election of Directors........................................    17
   3.12     Observer Rights..............................................    18
</TABLE>


                                        i
<PAGE>
<TABLE>
<S>         <C>                                                              <C>
   3.13     Termination of Covenants.....................................    18
SECTION 4   PREEMPTIVE RIGHTS............................................    19
   4.1      Subsequent Offerings.........................................    19
   4.2      Exercise of Preemptive Rights................................    19
   4.3      Termination and Waiver of Preemptive Right...................    19
   4.4      Transfer of Preemptive Rights................................    19
   4.5      Excluded Securities..........................................    20
SECTION 5   MISCELLANEOUS................................................    20
   5.1      Governing Law................................................    20
   5.2      Survival.....................................................    20
   5.3      Successors and Assigns.......................................    21
   5.4      Entire Agreement.............................................    21
   5.5      Severability.................................................    21
   5.6      Amendment and Waiver.........................................    21
   5.7      Delays or Omissions..........................................    22
   5.8      Notices......................................................    22
   5.9      Attorneys' Fees..............................................    22
   5.10     Titles and Subtitles.........................................    22
   5.11     Additional Investors.........................................    22
   5.12     Counterparts.................................................    23
   5.13     Joinder of Spouses...........................................    23
</TABLE>


                                       ii
<PAGE>
                          VALERA PHARMACEUTICALS, INC.

              SECOND AMENDED AND RESTATED INVESTOR RIGHTS AGREEMENT

     This SECOND AMENDED AND RESTATED INVESTOR RIGHTS AGREEMENT (this
"Agreement") is entered into as of August 16, 2004, by and among VALERA
PHARMACEUTICALS, INC., a Delaware corporation (the "Company"), the stockholders
of the Company listed as "Common Stock Investors" on EXHIBIT A hereto
(collectively, the "Common Stock Investors", and each individually, a "Common
Stock Investor"), the investors listed as the "Series C Investors" on EXHIBIT A
hereto (the "Series C Investors"), the stockholders of the Company listed as
"Series A Investors" on EXHIBIT A hereto (the "Series A Investors"), and the
stockholders of the Company listed as "Series B Investors" on EXHIBIT A hereto
(the "Series B Investors" and, together with the Common Stock Investors, the
Series C Investors and the Series A Investors, the "Investors").

                                    RECITALS

     The Series C Investors are purchasing shares of the Company's Series C
Convertible Preferred Stock pursuant to that certain Stock Purchase Agreement
(the "Purchase Agreement") of even date herewith (the "Financing").

     The obligations in the Purchase Agreement are conditioned upon the
execution and delivery of this Agreement.

     In connection with the consummation of the Financing, the parties desire to
enter into this Agreement in order to grant registration, information rights and
other rights to the Investors as set forth below.

                                    AGREEMENT

     In consideration of the premises and for other good and valuable
consideration, the receipt and sufficiency of which are hereby acknowledged,
intending to be legally bound hereby, the parties agree as follows:

     1. GENERAL.

          1.1. DEFINITIONS. As used in this Agreement the following terms shall
have the following respective meanings:

          "Board of Directors" means the Company's Board of Directors.

          "Certificate" means the Company's Restated Certificate of
Incorporation, as filed with the Delaware Secretary of State on August 16, 2004.

          "Common Stock" means the Company's common stock, par value $.001 per
share.

          "Equity Securities" means (i) any Common Stock, Preferred Stock, or
other security of the Company, (ii) any security convertible, with or without
consideration, into any
<PAGE>
Common Stock, Preferred Stock, or other security of the Company (including any
option to purchase such a convertible security), (iii) any security carrying any
warrant or right to subscribe to or purchase any Common Stock, Preferred Stock,
or other security of the Company, or (iv) any such warrant or right.

          "Exchange Act" means the Securities Exchange Act of 1934, as amended.

          "Form S-2" means such form under the Securities Act as in effect on
the date hereof or any successor or similar registration form under the
Securities Act subsequently adopted by the SEC that permits inclusion or
incorporation of certain information by reference to other documents filed by
the Company with the SEC.

          "Form S-3" means such form under the Securities Act as in effect on
the date hereof or any successor or similar registration form under the
Securities Act subsequently adopted by the SEC, which permits inclusion or
incorporation of substantial information by reference to other documents filed
by the Company with the SEC.

          "GP Strategies" means GP Strategies Corporation, a Delaware
corporation.

          "Holder" means any person owning of record Registrable Securities, or
securities convertible into Registrable Securities that have not been sold to
the public or any assignee of record of such Registrable Securities or
securities in accordance with Section 2.10 hereof.

          "Preferred Stock" means the Company's preferred stock, par value $.001
per share.

          "Qualified Offering" means a firm commitment underwritten public
offering of the Company's Common Stock, pursuant to an effective registration
statement under the Securities Act (i) at a public offering price per share,
before deductions for underwriter discounts and commissions, of at least three
(3) times the highest of the original purchase prices of the Series C
Convertible Preferred Stock, Series B Convertible Preferred Stock or Series A
Convertible Preferred Stock (subject to adjustment for any stock splits,
dividends, combinations, recapitalizations and the like), and (ii) with
aggregate proceeds to the Company of at least $25,000,000 before deductions for
underwriter discounts and commissions and any and all expenses of such
underwritten offering incurred by the Company.

          "Register," "registered," and "registration" refer to a registration
effected by preparing and filing a registration statement in compliance with the
Securities Act, and the declaration or ordering of effectiveness of such
registration statement or document.

          "Registrable Securities" means (a) Common Stock of the Company issued
or issuable upon conversion of the Shares, (b) for purposes of Section 2.3 and
2.4 only (and to the extent such provisions relate to Section 2.3 or 2.4,
Sections 2.1, 2.5, 2.6, 2.7, 2.8, 2.9, 2.10, 2.11, 2.12, 2.13, 2.14, 2.15 or
Section 5), Common Stock owned by GP Strategies, and (c) any Common Stock of the
Company issued as (or issuable upon the conversion or exercise of any warrant,
right or other security which is issued as) a dividend or other distribution
with respect to, or in exchange for or in replacement of, such above-described
securities. Notwithstanding the foregoing, Registrable Securities shall not
include any securities sold by a person to the public
<PAGE>
either pursuant to a registration statement or Rule 144 or sold in a private
transaction in which the transferor's rights under Section 2 of this Agreement
are not assigned.

          "Registrable Securities then outstanding" shall be the number of
shares determined by calculating the total number of shares of the Company's
Common Stock that are Registrable Securities and either (a) are then issued and
outstanding or (b) are issuable pursuant to then exercisable or convertible
securities, excluding any Registrable Securities as to which the rights under
Section 2 have terminated pursuant to Section 2.7.

          "Registration Expenses" mean all expenses incurred by the Company in
complying with Sections 2.2, 2.3 and 2.4 hereof, including, without limitation,
all registration and filing fees, printing expenses, fees and disbursements of
counsel for the Company, reasonable fees and disbursements of a single special
counsel for the Holders, blue sky fees and expenses and the expense of any
special audits incident to or required by any such registration (but excluding
the compensation of regular employees of the Company which shall be paid in any
event by the Company).

          "SEC" or "Commission" means the Securities and Exchange Commission.

          "Securities Act" means the Securities Act of 1933, as amended.

          "Selling Expenses" mean all underwriting discounts and selling
commissions applicable to the sale.

          "Series A Convertible Preferred Stock" means shares of the Company's
Preferred Stock designated as Series A Convertible Preferred Stock, par value
$.001 per share.

          "Series B Convertible Preferred Stock" means shares of the Company's
Preferred Stock designated as Series B 10% Convertible Preferred Stock, par
value $.001 per share.

          "Series C Convertible Preferred Stock" means shares of the Company's
Preferred Stock designated as Series C Convertible Preferred Stock, par value
$.001 per share.

          "Shares" mean (i) Series C Convertible Preferred Stock issued pursuant
to the Purchase Agreement held by the Series C Investors hereto and their
permitted assigns, (ii) Series B Convertible Preferred Stock held by the Series
B Investors and their permitted assigns, (iii) Series A Convertible Preferred
Stock held by the Series A Investors and their permitted assigns, and (iv) for
purposes of Section 2.3 and 2.4 only (and to the extent such provisions relate
to Section 2.3 or 2.4, Sections 2.1, 2.5, 2.6, 2.7, 2.8, 2.9, 2.10, 2.11, 2.12,
2.13 and 2.14 or Section 5), shares of Common Stock held by GP Strategies and
its permitted assigns.

          "Special Registration Statement" means a registration statement
relating to any employee benefit plan or with respect to any corporate
reorganization or other transaction under Rule 145 of the Securities Act.
<PAGE>
     2. RESTRICTIONS ON TRANSFER; REGISTRATION.

          2.1. RESTRICTIONS ON TRANSFER.

               (A) Each Holder agrees not to make any disposition of all or any
portion of the Shares or Registrable Securities unless and until:

                    (I) There is then in effect a registration statement under
the Securities Act covering such proposed disposition and such disposition is
made in accordance with such registration statement; or

                    (II) (A) The transferee has agreed in writing to be bound by
the terms of this Agreement, (B) such Holder shall have notified the Company of
the proposed disposition and shall have furnished the Company with a detailed
statement of the circumstances surrounding the proposed disposition, and (C) if
reasonably requested by the Company, such Holder shall have furnished the
Company with an opinion of counsel, reasonably satisfactory to the Company, that
such disposition will not require registration of such shares under the
Securities Act. It is agreed that the Company will not require opinions of
counsel for transactions made pursuant to Rule 144 except in unusual
circumstances.

               Notwithstanding the provisions of paragraphs (i) and (ii) above,
no such registration statement, detailed statement or opinion of counsel shall
be necessary for a transfer by a party hereto which is (A) a partnership to its
partners or former partners in accordance with partnership interests, (B) a
corporation to its shareholders in accordance with their interest in the
corporation, (C) a limited liability company to its members or former members in
accordance with their interest in the limited liability company, (D) to the
party's family member or trust for the benefit of an individual party, (E) an
entity which is controlled by, controls or is under common control with the
transferor (an "Affiliate"), or (F) a Common Stock Investor to another Common
Stock Investor or then current employees of the Company; provided that in each
case the transferee will be subject to the terms of this Agreement to the same
extent as if he, she or it were an original party hereunder.

               (B) Each certificate representing Shares or Registrable
Securities shall (unless otherwise permitted by the provisions of the Agreement)
be stamped or otherwise imprinted with a legend substantially similar to the
following (in addition to any legend required under applicable state securities
laws or under any other agreement):

     THE SHARES REPRESENTED BY THIS CERTIFICATE HAVE NOT BEEN REGISTERED UNDER
     THE SECURITIES ACT OF 1933, AS AMENDED, OR THE STATE SECURITIES OR BLUE SKY
     LAWS OF ANY JURISDICTION. SUCH SHARES MAY NOT BE SOLD, OFFERED FOR SALE,
     PLEDGED OR TRANSFERRED IN THE ABSENCE OF AN EFFECTIVE REGISTRATION
     STATEMENT AS TO THE SECURITIES UNDER SAID ACT AND SECURITIES LAWS OR AN
     OPINION OF COUNSEL SATISFACTORY TO THE CORPORATION THAT SUCH REGISTRATION
     IS NOT REQUIRED. COPIES OF THE AGREEMENTS COVERING THE PURCHASE OF THESE
     SHARES AND RESTRICTING THEIR TRANSFER MAY BE OBTAINED AT NO COST BY WRITTEN
     REQUEST MADE BY THE HOLDER OF RECORD
<PAGE>
     OF THIS CERTIFICATE TO THE SECRETARY OF THE CORPORATION AT THE PRINCIPAL
     EXECUTIVE OFFICES OF THE CORPORATION.

               (C) If such Shares or Registrable Securities are proposed to be
disposed of, the Company shall be obligated to reissue promptly certificates
without the foregoing legend at the request of any holder thereof if the holder
shall have obtained an opinion of counsel (which counsel may be counsel to the
Company) reasonably acceptable to the Company to the effect that the securities
may lawfully be so disposed of thereafter without registration, qualification,
or legend.

          2.2. DEMAND REGISTRATION.

               (A) Subject to the conditions of this Section 2.2, if the Company
shall receive a written request from a Holder or Holders of at least 50% of the
Registrable Securities then outstanding (the "Initiating Holders") that the
Company file a registration statement under the Securities Act covering the
registration of a majority of the Registrable Securities owned by such
Initiating Holders, then the Company shall, within 30 days of receipt thereof,
give written notice of such request to all Holders and, subject to the
limitations of this Section 2.2, use its commercially reasonable efforts to file
a registration statement under the Securities Act with the Commission covering
all Registrable Securities that the Initiating Holders request to be registered.

               (B) If the Initiating Holders intend to distribute the
Registrable Securities covered by their request by means of an underwriting,
they shall so advise the Company as a part of their request made pursuant to
this Section 2.2 and the Company shall include such information in the written
notice referred to in Section 2.2(a), as applicable. In such event, the right of
any Holder to include its Registrable Securities in such registration shall be
conditioned upon such Holder's participation in such underwriting and the
inclusion of such Holder's Registrable Securities in the underwriting to the
extent provided herein. All Holders proposing to distribute their securities
through such underwriting shall enter into an underwriting agreement in
customary form with the underwriter or underwriters selected for such
underwriting by the Company (which underwriter or underwriters shall be
reasonably acceptable to a majority in interest of the Initiating Holders).
Notwithstanding any other provision of this Section 2.2, if the underwriter
advises the Company that marketing factors require a limitation of the number of
securities to be underwritten (including Registrable Securities) then the
Company shall so advise all Holders of Registrable Securities that would
otherwise be underwritten pursuant hereto, and the number of shares that may be
included in the underwriting shall be allocated first to the Holders who are
holders of Series C Convertible Preferred Stock (or shares of Common Stock
issued upon conversion thereof), Series B Convertible Preferred Stock (or shares
of Common Stock issued upon conversion thereof) and Series A Convertible
Preferred Stock (or shares of Common Stock issued upon conversion thereof) on a
pro rata basis based on the total number of Registrable Securities held by such
Holders of Series C Convertible Preferred Stock, Series B Convertible Preferred
Stock and Series A Convertible Preferred Stock; provided, however, that the
number of shares of Registrable Securities to be included in such underwriting
and registration shall not be reduced unless all other securities of the Company
are first entirely excluded from the underwriting and registration, and in any
event, by not more than fifty-percent (50%) of the number of shares of
Registrable Securities requested to be so included. Any
<PAGE>
Registrable Securities excluded or withdrawn from such underwriting shall be
withdrawn from the registration.

               (C) The Company shall not be required to effect a registration
pursuant to this Section 2.2:

                    (1) prior to the earlier of (A) six months following a
Qualified Offering, and (B) December 31, 2005;

                    (2) after the Company has effected two (2) registrations
pursuant to Section 2.2(a), and such registrations have been declared or ordered
effective;

                    (3) during the period starting with the date of filing of,
and ending on the date 90 days following the effective date of, any registration
statement (other than a Special Registration Statement) of the Company;

                    (4) if within 30 days of receipt of a written request from
Initiating Holders pursuant to Section 2.2(a), the Company gives notice to the
Holders of the Company's intention to make a Qualified Offering within 90 days;

                    (5) if the Company shall furnish to the Initiating Holders,
a certificate signed by the Chairman of the Board of Directors stating that in
the good faith judgment of the Board of Directors, it would be seriously
detrimental to the Company and its stockholders for such registration statement
to be effected at such time, in which event the Company shall have the right to
defer such filing for a period of not more than 120 days after receipt of the
request of the Initiating Holders; provided that such right to delay a request
shall be exercised by the Company not more than once in any twelve-month period;
or

                    (6) if the Initiating Holders propose to dispose of shares
of Registrable Securities that may be immediately registered on Form S-3
pursuant to a request made pursuant to Section 2.4 below.

          2.3. PIGGYBACK REGISTRATIONS.  The Company shall notify all Holders of
Registrable Securities in writing at least 20 days prior to the filing of any
registration statement under the Securities Act for purposes of a public
offering of securities of the Company (including, but not limited to,
registration statements relating to secondary offerings of securities of the
Company, but excluding Special Registration Statements) and will afford each
such Holder an opportunity to include in such registration statement all or part
of such Registrable Securities held by such Holder. Each Holder desiring to
include in any such registration statement all or any part of the Registrable
Securities held by it shall, within 15 days after the above-described notice
from the Company, so notify the Company in writing. Such notice shall state the
intended method of disposition of the Registrable Securities by such Holder. If
a Holder decides not to include all of its Registrable Securities in any
registration statement thereafter filed by the Company, such Holder shall
nevertheless continue to have the right to include any Registrable Securities in
any subsequent registration statement or registration statements as may be filed
by the Company with respect to offerings of its securities, all upon the terms
and conditions set forth herein.
<PAGE>
               (A) UNDERWRITING. If the registration statement under which the
Company gives notice under this Section 2.3 is for an underwritten offering, the
Company shall so advise the Holders of Registrable Securities. In such event,
the right of any such Holder to be included in a registration pursuant to this
Section 2.3 shall be conditioned upon such Holder's participation in such
underwriting and the inclusion of such Holder's Registrable Securities in the
underwriting to the extent provided herein. All Holders proposing to distribute
their Registrable Securities through such underwriting shall enter into an
underwriting agreement in customary form with the underwriter or underwriters
selected for such underwriting by the Company. Notwithstanding any other
provision of the Agreement, if the underwriter determines in good faith that
marketing factors require a limitation of the number of shares to be
underwritten, the number of shares that may be included in the underwriting
shall be allocated, first, to the Company; second, to the Holders who are
holders of Series C Convertible Preferred Stock (or shares of Common Stock
issued upon conversion thereof), Series B Convertible Preferred Stock (or shares
of Common Stock issued upon conversion thereof) and Series A Convertible
Preferred Stock (or shares of Common Stock issued upon conversion thereof) on a
pro rata basis based on the total number of Registrable Securities held by such
Holders of Series C Convertible Preferred Stock, Series B Convertible Preferred
Stock and Series A Convertible Preferred Stock; and third, to the Holders who
are holders of Common Stock (issued otherwise than upon conversion of Series C
Convertible Preferred Stock, Series B Convertible Preferred Stock or Series A
Convertible Preferred Stock) on a pro rata basis based on the total number of
Registrable Securities held by such Holders; provided, however, that the number
of shares of Registrable Securities to be included in such underwriting and
registration shall not be reduced unless all other securities of the Company
(other than securities being offered by the Company and Registrable Securities
being offered by the Holders) are first entirely excluded from the underwriting
and registration. If any Holder disapproves of the terms of any such
underwriting, such Holder may elect to withdraw therefrom by written notice to
the Company and the underwriter, delivered at least ten business days prior to
the effective date of the registration statement. Any Registrable Securities
excluded or withdrawn from such underwriting shall be excluded and withdrawn
from the registration. For any Holder that is a partnership or corporation, the
partners, retired partners, stockholders and Affiliates of such Holder, or the
estates and family members of any such partners and retired partners and any
trusts for the benefit of any of the foregoing person shall be deemed to be a
single "Holder," and any pro rata reduction with respect to such "Holder" shall
be based upon the aggregate amount of shares of Registrable Securities owned by
all entities and individuals included in such "Holder," as defined in this
sentence.

               (B) RIGHT TO TERMINATE REGISTRATION. The Company shall have the
right to terminate or withdraw any registration initiated by it under this
Section 2.3 prior to the effectiveness of such registration whether or not any
Holder has elected to include securities in such registration. The Registration
Expenses of such withdrawn registration shall be borne by the Company in
accordance with Section 2.5 hereof.

          2.4. FORM S-2 AND S-3 REGISTRATION. In case the Company shall receive
from a Holder or Holders of at least 50% of the Registrable Securities then
outstanding a written request or requests that the Company effect a registration
on Form S-2 or Form S-3 or any similar short-form registration statement and any
related qualification or compliance with respect to all or a part of the
Registrable Securities owned by such Holder or Holders, the Company will:
<PAGE>
               (A) promptly give written notice of the proposed registration,
and any related qualification or compliance, to all other Holders of Registrable
Securities; and

               (B) as soon as practicable, use its best efforts to file such
registration statement as may be so requested and as would permit or facilitate
the sale and distribution of all or such portion of such Holder's Registrable
Securities as are specified in such request, together with all or such portion
of the Registrable Securities of any other Holder or Holders joining in such
request as are specified in a written request given within 15 days after receipt
of such written notice from the Company; provided, however, that the Company
shall not be obligated to effect any such registration, qualification or
compliance pursuant to this Section 2.4:

                    (I) if Form S-2 or Form S-3, as the case may be, is not
available for such offering by the Holders, or

                    (II) if the Company shall furnish to the Holders a
certificate signed by the Chairman of the Board of Directors stating that in the
good faith judgment of the Board of Directors, it would be seriously detrimental
to the Company and its stockholders for such Form S-2 or Form S-3 registration
to be effected at such time, in which event the Company shall have the right to
defer the filing of the registration statement for a period of not more than 90
days after receipt of the request of the Holder or Holders under this Section
2.4; provided, that such right to delay a request shall be exercised by the
Company not more than once in any twelve-month period, or

                    (III) in any particular jurisdiction in which the Company
would be required to qualify to do business or to execute a general consent to
service of process in effecting such registration, qualification or compliance,
or

                    (IV) if the Holders, together with the holders of any other
securities of the Company entitled to inclusion in such Form S-2 or Form S-3
registration statement, propose to sell Registrable Securities and such other
securities (if any) at an aggregate price to the public of less than $3,000,000;
or

                    (V) if the Company has filed a registration statement at the
request of Holders under this Section 2.4 within the preceding six months.

               (C) Subject to the foregoing, the Company shall file a Form S-2
or Form S-3 registration statement, as the case may be, covering the Registrable
Securities and other securities so requested to be registered as soon as
practicable after receipt of the request or requests of the Holders.
Registrations effected pursuant to this Section 2.4 shall not be counted as
demands for registration or registrations effected pursuant to Sections 2.2 or
2.3, respectively.

               (D) If the registration statement under which the Company gives
notice under this Section 2.4 is for an underwritten offering, the Company shall
so advise the Holders of Registrable Securities. In such event, the right of any
such Holder to be included in a registration pursuant to this Section 2.4 shall
be conditioned upon such Holder's participation in such underwriting and the
inclusion of such Holder's Registrable Securities in the underwriting to the
extent provided herein. All Holders proposing to distribute their Registrable
Securities through such underwriting shall enter into an underwriting agreement
in customary form with the
<PAGE>
underwriter or underwriters selected for such underwriting by the Company.
Notwithstanding any other provision of this Agreement, if the underwriter
determines in good faith that marketing factors require a limitation of the
number of shares to be underwritten, the number of shares that may be included
in the underwriting shall be allocated, first, to the Holders who are holders of
Series C Convertible Preferred Stock (or shares of Common Stock issued upon
conversion thereof), Series B Convertible Preferred Stock (or shares of Common
Stock issued upon conversion thereof) and Series A Convertible Preferred Stock
(or shares of Common Stock issued upon conversion thereof) on a pro rata basis
based on the total number of Registrable Securities held by such Holders of
Series C Convertible Preferred Stock, Series B Convertible Preferred Stock and
Series A Convertible Preferred Stock; and second, to the Holders who are holders
of Common Stock (issued other than upon conversion of the Series C Convertible
Preferred Stock, Series B Convertible Preferred Stock or Series A Convertible
Preferred Stock) on a pro rata basis based on the total number of Registrable
Securities held by such Holders; provided, however, that the number of shares of
Registrable Securities to be included in such underwriting and registration
shall not be reduced unless all other securities of the Company (other than
securities being offered by the Company and Registrable Securities being offered
by the Holders) are first entirely excluded from the underwriting and
registration. If any Holder disapproves of the terms of any such underwriting,
such Holder may elect to withdraw therefrom by written notice to the Company and
the underwriter, delivered at least ten (10) business days prior to the
effective date of the registration statement. Any Registrable Securities
excluded or withdrawn from such underwriting shall be excluded and withdrawn
from the registration. For any Holder which is a partnership or corporation, the
partners, retired partners, stockholders and Affiliates of such Holder, or the
estates and family members of any such partners and retired partners and any
trusts for the benefit of any of the foregoing person shall be deemed to be a
single "Holder," and any pro rata reduction with respect to such "Holder" shall
be based upon the aggregate amount of shares of Registrable Securities owned by
all entities and individuals included in such "Holder," as defined in this
sentence.

          2.5. EXPENSES OF REGISTRATION. Except as specifically provided
herein, all Registration Expenses incurred in connection with any registration,
qualification or compliance pursuant to Section 2.2 or any registration under
Section 2.3 or Section 2.4 herein shall be borne by the Company; provided,
however, that the Company shall not be required to pay any Registration Expenses
incurred in connection with any registration, qualification or compliance
proceedings begun pursuant to a request under Section 2.2 if such request is
subsequently withdrawn by the Holders of a majority of the Registrable
Securities to be included in such registration, qualification or compliance (in
which case all participating Holders shall bear all such Registration Expenses).
All Selling Expenses incurred in connection with any registrations hereunder,
shall be borne by the holders of the securities so registered pro rata on the
basis of the number of shares so registered and sold.

          2.6. OBLIGATIONS OF THE COMPANY. Whenever required to effect the
registration of any Registrable Securities, the Company shall, as expeditiously
as reasonably possible:

               (A) Prepare and file with the SEC a registration statement with
respect to such Registrable Securities and use all reasonable efforts to cause
such registration statement to become effective, and, upon the request of the
Holders of a majority of the Registrable Securities
<PAGE>
registered thereunder, keep such registration statement effective (i) in the
case of any registration under Section 2.2, for up to 180 days or, if earlier,
until the Holder or Holders have completed the distribution related thereto and
(ii) in the case of any registration under Section 2.4, indefinitely or, if
earlier, until the Holder or Holders have completed the distribution related
thereto.

               (B) Prepare and file with the SEC such amendments and supplements
to such registration statement and the prospectus used in connection with such
registration statement as may be necessary to comply with the provisions of the
Securities Act with respect to the disposition of all securities covered by such
registration statement for the period set forth in paragraph (a) above.

               (C) Furnish to the Holders such number of copies of a prospectus,
including a preliminary prospectus, in conformity with the requirements of the
Securities Act, and such other documents as they may reasonably request in order
to facilitate the disposition of Registrable Securities owned by them.

               (D) Use its reasonable efforts to register and qualify the
securities covered by such registration statement under such other securities or
Blue Sky laws of such jurisdictions as shall be reasonably requested by the
Holders; provided that the Company shall not be required in connection therewith
or as a condition thereto to qualify to do business or to file a general consent
to service of process in any such states or jurisdictions.

               (E) In the event of any underwritten public offering, enter into
and perform its obligations under an underwriting agreement, in usual and
customary form, with the managing underwriter(s) of such offering. Each Holder
participating in such underwriting shall also enter into and perform its
obligations under such an agreement.

               (F) Notify each Holder of Registrable Securities covered by such
registration statement at any time when a prospectus relating thereto is
required to be delivered under the Securities Act of the happening of any event
as a result of which the prospectus included in such registration statement, as
then in effect, includes an untrue statement of a material fact or omits to
state a material fact required to be stated therein or necessary to make the
statements therein not misleading in the light of the circumstances then
existing. The Company will use reasonable efforts to amend or supplement such
prospectus in order to cause such prospectus not to include any untrue statement
of a material fact or omit to state a material fact required to be stated
therein or necessary to make the statements therein not misleading in the light
of the circumstances then existing.

               (G) Use its reasonable efforts to furnish, on the date that such
Registrable Securities are delivered to the underwriters for sale, if such
securities are being sold through underwriters, (i) an opinion, dated as of such
date, of the counsel representing the Company for the purposes of such
registration, in form and substance as is customarily given to underwriters in
an underwritten public offering, addressed to the underwriters, if any, and (ii)
a letter dated as of such date, from the independent certified public
accountants of the Company, in form and substance as is customarily given by
independent certified public accountants to underwriters in an underwritten
public offering addressed to the underwriters.
<PAGE>
               (H) Use reasonable efforts to cause all such Registrable
Securities to be listed on each securities exchange on which similar securities
issued by the Company are then listed and to be qualified for trading on each
system on which securities issued by the Company are from time to time
qualified.

               (I) Use its reasonable efforts to provide a transfer agent and
registrar for all such Registrable Securities not later than the effective date
of such registration statement and thereafter maintain such transfer agent and
registrar.

               (J) Use its reasonable efforts to provide a CUSIP number for all
Registrable Securities, not later than the effective date of the applicable
registration statement.

          2.7. TERMINATION OF REGISTRATION RIGHTS. All registration rights
granted under Sections 2.2, 2.3, and 2.4 shall terminate and be of no further
force and effect with respect to any Holder when all Registrable Securities held
by and issuable to such Holder (and its Affiliates, partners, former partners,
members and former members) may be sold under Rule 144 during any 90-day period.

          2.8. DELAY OF REGISTRATION; FURNISHING INFORMATION.

               (A) No Holder shall have any right to obtain or seek an
injunction restraining or otherwise delaying any such registration as the result
of any controversy that might arise with respect to the interpretation or
implementation of this Section 2.

               (B) It shall be a condition precedent to the obligations of the
Company to take any action pursuant to Section 2.2, 2.3, or 2.4 that the selling
Holders shall furnish to the Company such information regarding themselves, the
Registrable Securities held by them and the intended method of disposition of
such securities as shall be required to effect the registration of their
Registrable Securities.

          2.9. INDEMNIFICATION. In the event any Registrable Securities are
included in a registration statement under Section 2.2, 2.3, or 2.4:

               (A) To the extent permitted by law, the Company will indemnify
and hold harmless each Holder, the partners, members, officers and directors of
each Holder, any underwriter (as defined in the Securities Act) for such Holder
and each person, if any, who controls such Holder or underwriter within the
meaning of the Securities Act or the Exchange Act, against any losses, claims,
damages or liabilities (joint or several) to which they may become subject under
the Securities Act, the Exchange Act or other federal or state law, insofar as
such losses, claims, damages or liabilities (or actions in respect thereof)
arise out of or are based upon any of the following statements, omissions or
violations (collectively a "Violation") by the Company: (i) any untrue statement
or alleged untrue statement of a material fact contained in such registration
statement, including any preliminary prospectus or final prospectus contained
therein or any amendments or supplements thereto, (ii) the omission or alleged
omission to state therein a material fact required to be stated therein, or
necessary to make the statements therein not misleading, or (iii) any violation
or alleged violation by the Company of the Securities Act, the Exchange Act, any
state securities law or any rule or regulation promulgated under the Securities
Act, the Exchange Act or any state securities law in connection with the
offering
<PAGE>
covered by such registration statement; and the Company will pay as incurred to
each such Holder, partner, officer, director, underwriter or controlling person
for any legal or other expenses reasonably incurred by them in connection with
investigating or defending any such loss, claim, damage, liability or action;
provided however, that the indemnity agreement contained in this Section 2.9(a)
shall not apply to amounts paid in settlement of any such loss, claim, damage,
liability or action if such settlement is effected without the consent of the
Company, which consent shall not be unreasonably withheld, nor shall the Company
be liable in any such case for any such loss, claim, damage, liability or action
to the extent that it arises out of or is based upon a Violation which occurs
in reliance upon and in conformity with written information furnished expressly
for use in connection with such registration by such Holder, or by any partner,
member, officer, director, underwriter or controlling person of such Holder; and
provided, further, that such indemnity shall not apply with respect to any
untrue statement or alleged untrue statement or omission or alleged omission in
any preliminary or final prospectus if the prospectus (as amended or
supplemented), as provided to the person claiming indemnification prior to the
time the Company made the sale to the person making the claim of a Violation,
did not contain such statement or alleged statement or omission or alleged
omission.

               (B) To the extent permitted by law, each Holder will, if
Registrable Securities held by such Holder are included in the securities as to
which such registration qualifications or compliance is being effected,
indemnify and hold harmless the Company, each of its directors, its officers and
each person, if any, who controls the Company within the meaning of the
Securities Act or the Exchange Act, any underwriter and any other Holder selling
securities under such registration statement or any of such other Holder's
partners, directors or officers or any person who controls such Holder, against
any losses, claims, damages or liabilities (joint or several) to which the
Company or any such director, officer, controlling person, underwriter or other
such Holder, or partner, director, officer or controlling person of such other
Holder may become subject under the Securities Act, the Exchange Act or other
federal or state law, insofar as such losses, claims, damages or liabilities (or
actions in respect thereto) arise out of or are based upon any Violation, in
each case to the extent (and only to the extent) that such Violation occurs in
reliance upon and in conformity with written information furnished by such
Holder in writing expressly for use in connection with such registration; and
each such Holder will pay as incurred any legal or other expenses reasonably
incurred by the Company or any such director, officer, controlling person,
underwriter or other Holder, or partner, officer, director or controlling person
of such other Holder in connection with investigating or defending any such
loss, claim, damage, liability or action if it is judicially determined that
there was such a Violation; provided, however, that the indemnity agreement
contained in this Section 2.9(b) shall not apply to amounts paid in settlement
of any such loss, claim, damage, liability or action if such settlement is
effected without the consent of the Holder, which consent shall not be
unreasonably withheld; provided further, that in no event shall any indemnity
under this Section 2.9 exceed the net proceeds from the offering received by
such Holder.

               (C) Promptly after receipt by an indemnified party under this
Section 2.9 of notice of the commencement of any action (including any
governmental action), such indemnified party will, if a claim in respect
thereof is to be made against any indemnifying party under this Section 2.9,
deliver to the indemnifying party a written notice of the commencement thereof
and the indemnifying party shall have the right to participate in, and, to the
extent the
<PAGE>
indemnifying party so desires, jointly with any other indemnifying party
similarly noticed, to assume the defense thereof with counsel mutually
satisfactory to the parties; provided, however, that an indemnified party shall
have the right to retain its own counsel, with the fees and expenses to be paid
by the indemnifying party, if representation of such indemnified party by the
counsel retained by the indemnifying party would be inappropriate due to actual
or potential differing interests between such indemnified party and any other
party represented by such counsel in such proceeding. The failure to deliver
written notice to the indemnifying party within a reasonable time of the
commencement of any such action, if materially prejudicial to its ability to
defend such action, shall relieve such indemnifying party of any liability to
the indemnified party under this Section 2.9, but the omission so to deliver
written notice to the indemnifying party will not relieve it of any liability
that it may have to any indemnified party otherwise than under this Section 2.9.

               (D) If the indemnification provided for in this Section 2.9 is
held by a court of competent jurisdiction to be unavailable to an indemnified
party with respect to any losses, claims, damages or liabilities referred to
herein, the indemnifying party, in lieu of indemnifying such indemnified party
thereunder, shall to the extent permitted by applicable law contribute to the
amount paid or payable by such indemnified party as a result of such loss,
claim, damage or liability in such proportion as is appropriate to reflect the
relative fault of the indemnifying party on the one hand and of the indemnified
party on the other in connection with the Violation(s) that resulted in such
loss, claim, damage or liability, as well as any other relevant equitable
considerations. The relative fault of the indemnifying party and of the
indemnified party shall be determined by a court of law by reference to, among
other things, whether the untrue or alleged untrue statement of a material fact
or the omission to state a material fact relates to information supplied by the
indemnifying party or by the indemnified party and the parties' relative intent,
knowledge, access to information and opportunity to correct or prevent such
statement or omission; provided, that in no event shall any contribution by a
Holder hereunder exceed the net proceeds from the offering received by such
Holder.

               (E) The obligations of the Company and Holders under this Section
2.9 shall survive completion of any offering of Registrable Securities in a
registration statement and the termination of this Agreement. No Indemnifying
Party, in the defense of any such claim or litigation, shall, except with the
consent of each Indemnified Party, consent to entry of any judgment or enter
into any settlement which does not include as an unconditional term thereof the
giving by the claimant or plaintiff to such Indemnified Party of a release from
all liability in respect to such claim or litigation.

          2.10. ASSIGNMENT OF REGISTRATION RIGHTS.

               (A) The rights to cause the Company to register Registrable
Securities pursuant to this Section 2 may be assigned by a Holder to a
transferee or assignee of Registrable Securities which (i) is a subsidiary,
parent, Affiliate, general partner, limited partner, retired partner, member,
retired member or shareholder of a Holder, (ii) is a Holder's family member or
trust for the benefit of an individual Holder or (iii) acquires at least 100,000
shares of such Holder's Registrable Securities (as adjusted for any stock
dividend, combination, splits, reorganization, and the like); provided, however,
(A) the transferor shall, within ten (10) days after such transfer, furnish to
the Company written notice of the name and address of such
<PAGE>
transferee or assignee and the securities with respect to which such
registration rights are being assigned and (B) such transferee shall agree to be
subject to all restrictions set forth in this Agreement.

               (B) Notwithstanding anything to the contrary contained in this
Section 2.10, no assignment under Section 2.10(a) shall be valid if the
transferee of the Registrable Securities of a Holder is determined in good faith
by the Board of Directors to be a direct competitor of the Company.

          2.11. AMENDMENT OF REGISTRATION RIGHTS. Any provision of this Section
2 may be amended and the observance thereof may be waived (either generally or
in a particular instance and either retroactively or prospectively), only with
the written consent of the Company and the Holders of at least a majority of the
Registrable Securities then outstanding. Any amendment or waiver effected in
accordance with this Section 2.11 shall be binding upon each Holder and the
Company. By acceptance of any benefits under this Section 2, Holders of
Registrable Securities hereby agree to be bound by the provisions hereunder.

          2.12. LIMITATION ON SUBSEQUENT REGISTRATION RIGHTS. Other than as
provided in Section 5.11, after the date of this Agreement, the Company shall
not, without the prior written consent of the Holders of at least a majority of
the Registrable Securities then outstanding, enter into any agreement with any
holder or prospective holder of any securities of the Company that would grant
such holder registration rights pari passu or senior to those granted to the
Holders hereunder.

          2.13. "MARKET STAND-OFF" AGREEMENT. Each Holder hereby agrees that
such Holder shall not sell, transfer, make any short sale of, grant any option
for the purchase of, or enter into any hedging or similar transaction with the
same economic effect as a sale of, any Common Stock (or other securities) of the
Company held by such Holder (other than those included in the registration) for
a period specified by the representative of the underwriters of Common Stock (or
other securities) of the Company not to exceed 180 days following the effective
date of a registration statement of the Company filed under the Securities Act;
provided that such agreement shall apply only to the Company's initial Qualified
Offering.

          2.14. AGREEMENT TO FURNISH INFORMATION. Each Holder agrees to execute
and deliver such other agreements as may be reasonably requested by the Company
or the underwriter which are consistent with the foregoing or which are
necessary to give further effect thereto. In addition, if requested by the
Company or the representative of the underwriters of Common Stock (or other
securities) of the Company, each Holder shall provide, within ten (10) days of
such request, such information as may be required by the Company or such
representative in connection with the completion of any public offering of the
Company's securities pursuant to a registration statement filed under the
Securities Act.

          2.15. RULE 144 REPORTING. With a view to making available to the
Holders the benefits of certain rules and regulations of the SEC which may
permit the sale of the Registrable Securities to the public without
registration, the Company agrees to use its best efforts to:
<PAGE>
               (A) Make and keep public information available, as those terms
are understood and defined in SEC Rule 144 or any similar or analogous rule
promulgated under the Securities Act, at all times after the effective date of
the first registration filed by the Company for an offering of its securities to
the general public;

               (B) File with the SEC, in a timely manner, all reports and other
documents required of the Company under the Exchange Act; and

               (C) So long as a Holder owns any Registrable Securities, furnish
to such Holder forthwith upon request: a written statement by the Company as to
its compliance with the reporting requirements of said Rule 144 of the
Securities Act, and of the Exchange Act (at any time after it has become subject
to such reporting requirements); a copy of the most recent annual or quarterly
report of the Company; and such other reports and documents as a Holder may
reasonably request in availing itself of any rule or regulation of the SEC
allowing it to sell any such securities without registration.

     3. COVENANTS.

          3.1. BASIC FINANCIAL INFORMATION AND REPORTING.

               (A) The Company will maintain true books and records of account
in which full and correct entries will be made of all its business transactions
pursuant to a system of accounting established and administered in accordance
with generally accepted accounting principles consistently applied, and will set
aside on its books all such proper accruals and reserves as shall be required
under generally accepted accounting principles consistently applied.

               (B) As long as shares of Series C Convertible Preferred Stock,
Series B Convertible Preferred Stock, Series A Convertible Preferred Stock,
and/or Registrable Securities issued therefore are outstanding, the Company
shall deliver or provide to each Series C Investor, Series B Investor and Series
A Investor (so long as such Investor continues to hold 10% of the Shares
originally purchased by said Series C Investor, Series B Investor or Series A
Investor and/or Registrable Securities issued therefore) of each respective
class, and as long as GP Strategies holds at least 10% of the outstanding Common
Stock, the Company shall deliver and provide to GP Strategies:

                    (I) Within 90 days after the end of each fiscal year of the
Company, a balance sheet of the Company, as at the end of such fiscal year, and
a statement of income and a statement of cash flows of the Company, for such
year, all prepared in accordance with generally accepted accounting principles
consistently applied and setting forth in each case in comparative form the
figures for the previous fiscal year, all in reasonable detail. Such financial
statements shall be accompanied by a report and opinion thereon by independent
public accountants of national standing selected by the Board of Directors; and

                    (II) (A) At least 30 days prior to the beginning of each
fiscal year, an annual budget and operating plans for such fiscal year (and as
soon as available, any subsequent revisions thereto); and (B) within 20 days
after the end of each quarter, a balance sheet of the Company as of the end of
each such quarter, and a statement of income and a statement of cash flows of
the Company for such quarter and for the current fiscal year to date,
<PAGE>
prepared in accordance with generally accepted accounting principles
consistently applied, with the exception that no notes need be attached to such
statements and year-end audit adjustments may not have been made.

          3.2. INSPECTION RIGHTS. As long as Series C Convertible Preferred
Stock, Series B Convertible Preferred Stock, Series A Convertible Preferred
Stock, and/or Registrable Securities issued therefore are outstanding, each
Series C Investor, Series B Investor and Series A Investor (so long as such
Investor continues to hold 10% of the Shares originally purchased by said
Investor and/or Registrable Securities issued therefore), and as long as GP
Strategies holds at least 10% of the outstanding Common Stock, GP Strategies,
after giving reasonable advance notice to the Company, shall have the right
during normal business hours to visit and inspect any of the properties of the
Company or any of its subsidiaries, and to discuss the affairs, finances and
accounts of the Company or any of its subsidiaries with its officers, and to
review such information as is reasonably requested all at such reasonable times
and as often as may be reasonably requested; provided, however, that the Company
shall not be obligated under this Section 3.2 with respect to a direct
competitor of the Company or with respect to information which the Board of
Directors determines in good faith is confidential and should not, therefore, be
disclosed.

          3.3. CONFIDENTIALITY OF RECORDS. Each Investor agrees to use, and to
use its reasonable commercial efforts to insure that its authorized
representatives use, the same degree of care as such Investor uses to protect
its own confidential information to keep confidential any information furnished
to it which the Company identifies as being confidential or proprietary (so long
as such information is not in the public domain), except that such Investor may
disclose such proprietary or confidential information to any partner, Affiliate,
subsidiary or parent of such Investor for the purpose of evaluating its
investment in the Company as long as such partner, subsidiary or parent is
advised of and agrees to abide by the confidentiality provisions of this Section
3.3 or provisions that are substantially similar thereto. Notwithstanding the
foregoing, each Investor (and each employee, representative, or other agent of
such Investor) may disclose to any and all persons, without limitations of any
kind, the tax treatment and tax structure of the transactions contemplated by
this Agreement and all materials of any kind (including opinions or other tax
analysis) that are provided to such Investor relating to such tax treatment and
tax structure.

          3.4. RESERVATION OF COMMON STOCK. The Company will at all times
reserve and keep available, solely for issuance and delivery upon the conversion
of the Shares, all Common Stock issuable from time to time upon such conversion.

          3.5. STOCK VESTING. Except as otherwise provided by the Board of
Directors, all stock options and other stock equivalents issued by the Company
after the date of this Agreement to employees, directors, consultants and other
service providers of the Company shall be subject to vesting as follows: (a) 25%
of such stock shall vest at the end of the first year following the date of
issuance, and (b) 75% of such stock shall vest on a monthly basis over the
remaining three years. With respect to any shares of stock purchased by any such
person, except as otherwise provided by the Board of Directors, the Company will
enter into an agreement in connection with each such issuance of stock to an
employee, director or consultant of the Company that provides that upon the
termination of the employment or service of such
<PAGE>
employee, director or consultant, with or without cause with respect to any
unvested shares or options owned or held by an employee, director or consultant
of the Company, such unvested shares or options shall be forfeited to the
Company or its assignee.

          3.6. SPECIAL RELATIONSHIPS OF PROSPECTIVE EMPLOYEES. The Company shall
not hire or contract for the services, directly or indirectly, whether as an
employee, independent contractor, consultant or in any other capacity, of any
person who is a spouse, sibling, parent, child, or other family member of a
current officer, director, employee, independent contractor or consultant to the
Company without the unanimous consent of the Board of Directors of the Company.

          3.7. DIRECTORS' LIABILITY AND INDEMNIFICATION. The Company's
Certificate of Incorporation and Bylaws shall provide (a) for elimination of the
liability of directors to the maximum extent permitted by law and (b) for
indemnification of directors for acts on behalf of the Company to the maximum
extent permitted by law.

          3.8. REIMBURSEMENT OF EXPENSES. The Company shall reimburse each
nonemployee member of the Board of Directors for all reasonable and customary
actual expenses incurred in connection with their service as a member of the
Board of Directors, including without limitation all actual travel and lodging
expenses incurred in connection with the attendance by any such member at a
meeting of the Board of Directors or any committee thereof.

          3.9. QUALIFIED SMALL BUSINESS. The Company will use its best efforts
to comply with the reporting and recordkeeping requirements of Section 1202 of
the Internal Revenue Code of 1986, as amended, any regulations promulgated
thereunder and any similar state laws and regulations, and agrees not to
repurchase any stock of the Company if such repurchase would cause the Shares
not to so qualify as "Qualified Small Business Stock."

          3.10. ELECTION OF DIRECTORS.

               (A) In any election of directors of the Company, the Investors
shall vote at any regular meeting or special meeting of stockholders of the
Company (or by written consent) such number of shares of voting capital stock
then owned by them (or as to which they then have voting power) as may be
necessary to elect the following individuals to the Board of Directors:

                    (I) One director designated by the Corporate Opportunities
Fund, L.P., who shall initially be James C. Gale;

                    (II) One director designated by Wheatley MedTech Partners
L.P.;

                    (III) One director designated by GP Strategies;

                    (IV) One director designated by SMH Hydro Med II, LLC;

                    (V) One director designated by Psilos Group Managers, LLC,
who shall also have the right to be a member of the audit committee of the Board
of Directors;
<PAGE>
                    (VI) Two directors who have relevant industry experience and
are not employees of the Company or GP Strategies, nominated by mutual agreement
of the Investors (the "Outside Directors"); and

                    (VII) The President or Chief Executive Officer of the
Company.

               (B) Any director nominated pursuant to Section 3.10(a)(i), (ii),
(iii) (iv) or (v) may be removed by, and shall not be removed except by,
Corporate Opportunities Fund, L.P., Wheatley MedTech Partners L.P., GP
Strategies, SMH Hydro Med II, LLC; and Psilos Group Managers, LLC, respectively.

          3.11. OBSERVER RIGHTS. As long as SMH Hydro Med LLC, Paladin Labs,
Inc. and NJTC Venture Fund SBIC, L.P., respectively, hold any Shares, the
Company shall, if such Investors do not otherwise have a representative on the
Board of Directors, invite a representative of each such Investor to attend all
meetings of its Board of Directors and the committees of the Board of Directors
in a nonvoting observer capacity and, in this respect, shall give such
representative copies of all notices, minutes, consents, and other materials
that it provides to its directors; provided, however, that such representative
shall agree to hold in confidence and trust and to act in a fiduciary manner
with respect to all information so provided; and, provided further, that the
Company reserves the right to withhold any information and to exclude such
representative from any meeting or portion thereof if access to such information
or attendance at such meeting could adversely affect the attorney-client
privilege between the Company and its counsel.

          3.12. TERMINATION OF COVENANTS. All covenants of the Company contained
in Section 3 of this Agreement shall expire and terminate as to each Investor
upon the earlier of (a) the effective date of the registration statement
pertaining to the initial Qualified Offering, or (b) upon (i) the acquisition of
the Company by another entity by means of any transaction or series of related
transactions, including, without limitation, any reorganization, merger or
consolidation but, excluding any merger effected exclusively for the purpose of
changing the domicile of the Company or (ii) a sale of all or substantially all
of the assets of the Company (a "Change in Control"); provided that in the event
that the Company's stockholders of record as constituted immediately prior to
any such transaction (on a fully diluted basis) will, immediately after such
transaction (by virtue of securities issued as consideration for the Company's
acquisition or sale or otherwise), hold at least 50% of the voting power of the
surviving or acquiring entity, such transaction shall not be deemed to
constitute a Change in Control.

     4. PREEMPTIVE RIGHTS.

          4.1. SUBSEQUENT OFFERINGS. In the event the Company issues and sells
Equity Securities (as defined below) other than the Equity Securities excluded
by Section 4.5 hereof, each Investor shall have a preemptive right to purchase
such number of shares of Equity Securities or debt securities necessary for such
Investor to maintain its percentage ownership position in the Company on an as
converted basis. Each Investor's preemptive share is equal to the ratio of (a)
the number of shares of the Company's Common Stock (including all shares of
Common Stock issued or issuable upon conversion of the Series C Convertible
Preferred Stock, Series B Convertible Preferred Stock or Series A Convertible
Preferred Stock) of which such
<PAGE>
Investor is deemed to be a holder immediately prior to the issuance of such
Equity Securities to (b) the total number of shares of the Company's outstanding
Common Stock (including all shares of Common Stock issued or issuable upon
conversion of the Series C Convertible Preferred Stock, Series B Convertible
Preferred Stock, Series A Convertible Preferred Stock, or other security of the
Company or upon the exercise of any outstanding warrants, options, or rights to
subscribe to or purchase any Common Stock, Preferred Stock, or other security)
immediately prior to the issuance of the Equity Securities (as to each Investor,
its "pro rata share"). In the event the Company issues and sells debt securities
to any stockholder of the Company ("Debt Securities"), each Investor shall have
a similar preemptive right to purchase its pro rata share of such debt
securites.

          4.2. EXERCISE OF PREEMPTIVE RIGHTS. If the Company issues any Equity
Securities or Debt Securities, it shall give each Investor written notice of
such issuance, describing the Equity Securities or Debt Securities and the price
and the terms and conditions upon which the Company issued the same and shall
provide each Investor with access to any information regarding such offering and
the Company, provided to the purchasers of Equity Securities or Debt Securities.
Each Investor shall have 45 days from the giving of such notice to exercise its
preemptive right to purchase Equity Securities or Debt Securities for the price
and upon the terms and conditions specified in the notice by giving written
notice to the Company and stating therein the quantity of Equity Securities or
Debt Securities to be purchased. Notwithstanding the foregoing, the Company
shall not be required to offer or sell such Equity Securities or Debt Securities
to any Investor who would cause the Company to be in violation of applicable
federal securities laws by virtue of such offer or sale.

          4.3. TERMINATION AND WAIVER OF PREEMPTIVE RIGHTS. The preemptive
rights established by this Section 4 shall terminate following the Company's
initial Qualified Offering.

          4.4. TRANSFER OF PREEMPTIVE RIGHTS. The preemptive rights of each
Investor under this Section 4 may be transferred to the same parties, subject to
the same restrictions, as any transfer of registration rights pursuant to
Section 2.10.

          4.5. EXCLUDED SECURITIES. The preemptive rights established by this
Section 4 shall have no application to any of the following Equity Securities:

               (A) up to 7,850,000 shares (as may be adjusted for any stock
dividend, combinations, splits, recapitalizations and the like) of Common Stock
(and/or options, warrants or other Common Stock purchase rights issued pursuant
to such options, warrants or other rights) issued or to be issued after the date
hereof to employees, officers or directors of, or consultants or advisors to the
Company or any subsidiary, pursuant to stock purchase or stock option plans or
other arrangements that are approved by the Board of Directors;

               (B) capital stock of the Company issued pursuant to any rights or
agreements outstanding as of the date of this Agreement, options and warrants
outstanding as of the date of this Agreement, and capital stock issued pursuant
to or upon the exercise of any such rights or agreements granted after the date
of this Agreement; provided that in the case of rights or agreements granted
after the date of this Agreement, such rights or agreements were approved
<PAGE>
by the Board of Directors, including representatives designated by Sanders
Morris Harris and Wheatley MedTech Partners L.P.;

               (C) shares of Common Stock issued in connection with any stock
split, dividend, combination, distribution, or recapitalization;

               (D) shares of Common Stock issued in connection with any merger,
consolidation, acquisition, or similar business combination approved by the
Board of Directors;

               (E) shares of Common Stock issued upon conversion of the Shares;

               (F) any Equity Securities issued pursuant to any equipment
leasing or loan arrangement, or debt financing from a bank or similar financial
or lending institution approved by the Board of Directors; and

               (G) any Equity Securities issued in connection with strategic
transactions involving the Company and other entities, including (i) joint
ventures, manufacturing, marketing or distribution arrangements or (ii)
technology transfer or development arrangements; provided that such strategic
transactions and the issuance of shares therein, has been approved by the Board
of Directors.

     5. MISCELLANEOUS.

          5.1. GOVERNING LAW. This Agreement shall be governed by and construed
under the laws of the State of Delaware, without regard to principals of
conflict of laws.

          5.2. SURVIVAL. The representations, warranties, covenants, and
agreements made herein shall survive any investigation made by any Holder and
the closing of the transactions contemplated hereby. All statements as to
factual matters contained in any certificate or other instrument delivered by or
on behalf of the Company pursuant hereto in connection with the transactions
contemplated hereby shall be deemed to be representations and warranties by the
Company hereunder solely as of the date of such certificate or instrument.

          5.3. SUCCESSORS AND ASSIGNS. Except as otherwise expressly provided
herein, the provisions hereof shall inure to the benefit of, and be binding
upon, the successors, assigns, heirs, executors, and administrators of the
parties hereto and shall inure to the benefit of and be enforceable by each
person who shall be a holder of Registrable Securities from time to time;
provided, however, that prior to the receipt by the Company of adequate written
notice of the transfer of any Registrable Securities in accordance with this
Agreement, such notice to specify the full name and address of the transferee,
the Company may deem and treat the person listed as the holder of such shares in
its records as the absolute owner and holder of such shares for all purposes,
including the payment of dividends or any redemption price.

          5.4. ENTIRE AGREEMENT. This Agreement, the Exhibits and Schedules
hereto, the Purchase Agreement and the other documents delivered pursuant
thereto constitute the full and entire understanding and agreement between the
parties with regard to the subjects hereof and no party shall be liable or bound
to any other in any manner by any representations, warranties, covenants and
agreements except as specifically set forth herein and therein. This
<PAGE>
Agreement replaces and supercedes the Amended and Restated Investor Rights
Agreement dated May 30, 2003 by and among the Company, the Common Investors, the
Series A Investors and the Series B Investors.

          5.5. SEVERABILITY. In the event one or more of the provisions of this
Agreement should, for any reason, be held to be invalid, illegal or
unenforceable in any respect, such invalidity, illegality, or unenforceability
shall not affect any other provisions of this Agreement, and this Agreement
shall be construed as if such invalid, illegal or unenforceable provision had
never been contained herein.

          5.6. AMENDMENT AND WAIVER.

               (A) Except as otherwise expressly provided, this Agreement may be
amended or modified only upon the written consent of the Company and the Holders
of at least a majority of the Registrable Securities; provided that any
provision which by its terms is intended to benefit a specific party or parties
may only be amended upon the written consent of such party or parties.

               (B) Except as otherwise expressly provided, the obligations of
the Company and the rights of the Holders under this Agreement may be waived
only with the written consent of the Holders of at least a majority of the
Registrable Securities; provided that any provision which by its terms is
intended to benefit a specific party or parties may only be waived with the
written consent of such party or parties.

               (C) Notwithstanding the foregoing, this Agreement may be amended
with only the written consent of the Company to include additional purchasers of
Series C Convertible Preferred Stock as "Series C Investors," "Holders," and
parties hereto.

               (D) For the purposes of determining the number of Holder or
Investors entitled to vote or exercise any rights hereunder, the Company shall
be entitled to rely solely on the list of record holders of its stock as
maintained by or on behalf of the Company.

          5.7. DELAYS OR OMISSIONS. It is agreed that no delay or omission to
exercise any right, power, or remedy accruing to any Holder, upon any breach,
default or noncompliance of the Company under this Agreement shall impair any
such right, power, or remedy, nor shall it be construed to be a waiver of any
such breach, default or noncompliance, or any acquiescence therein, or of any
similar breach, default or noncompliance thereafter occurring. It is further
agreed that any waiver, permit, consent, or approval of any kind or character on
any Holder's part of any breach, default or noncompliance under the Agreement or
any waiver on such Holder's part of any provisions or conditions of this
Agreement must be in writing and shall be effective only to the extent
specifically set forth in such writing. All remedies, either under this
Agreement, by law, or otherwise afforded to Holders, shall be cumulative and not
alternative.

          5.8. NOTICES. All notices required or permitted hereunder shall be in
writing and shall be deemed effectively given: (a) upon personal delivery to the
party to be notified, (b) when sent by confirmed electronic mail or facsimile if
sent during normal business hours of the recipient; if not, then on the next
business day, (c) five days after having been sent by registered or certified
mail, return receipt requested, postage prepaid, or (d) one day after deposit
<PAGE>
with a nationally recognized overnight courier, specifying next day delivery,
with written verification of receipt. All communications shall be sent to the
party to be notified at the address as set forth on the signature pages hereof
or Exhibit A hereto or at such other address as such party may designate by ten
days advance written notice to the other parties hereto.

          5.9. ATTORNEYS' FEES. In the event that any suit or action is
instituted to enforce any provision in this Agreement, the prevailing party in
such dispute shall be entitled to recover from the losing party all reasonable
fees, costs and expenses of enforcing any right of such prevailing party under
or with respect to this Agreement, including without limitation, such reasonable
fees and expenses of attorneys and accountants, which shall include, without
limitation, all fees, costs and expenses of appeals.

          5.10. TITLES AND SUBTITLES. The titles of the sections and subsections
of this Agreement are for convenience of reference only and are not to be
considered in construing this Agreement.

          5.11. ADDITIONAL INVESTORS. Notwithstanding anything to the contrary
contained herein, if the Company shall issue additional shares of its Preferred
Stock pursuant to the Purchase Agreement, any purchaser of such shares of
Preferred Stock may become a party to this Agreement by executing and delivering
an additional counterpart signature page to this Agreement and shall be deemed
an "Investor" hereunder.

          5.12. COUNTERPARTS. This Agreement may be executed in any number of
counterparts, each of which shall be an original, but all of which together
shall constitute one instrument.

          5.13. JOINDER OF SPOUSES. The undersigned spouses of each Investor, if
applicable, join in the execution and delivery of this Agreement for the express
purpose of binding any interest he or she may have in the Shares or Common
Stock.

                         [SIGNATURES ON FOLLOWING PAGES]
<PAGE>
     IN WITNESS WHEREOF, the parties hereto have executed this SECOND AMENDED
AND RESTATED INVESTOR RIGHTS AGREEMENT as of the date set forth in the first
paragraph hereof.

COMPANY:                                INVESTORS:

VALERA PHARMACEUTICALS, INC.            SMH HYDRO MED LLC


BY: /s/ David S. Tierney                BY:
    ---------------------------------       ------------------------------------
    Name: David S. Tierney                  Name: James C. Gale
    Title: President                        Title: Manager


                                        SMH HYDRO MED II LLC


                                        BY:
                                            ------------------------------------
                                            Name: James C. Gale
                                            Title: Manager


                                        SMH VALERA LLC


                                        By:
                                            ------------------------------------
                                            Name: James C. Gale
                                            Title: Manager


                                        CORPORATE OPPORTUNITIES FUND, L.P.
                                        By: SMM Corporate Management, LLC,
                                            General Partner


                                        By:
                                            ------------------------------------
                                            Name: James C. Gale
                                            Title: Manager


                                        CORPORATE OPPORTUNITIES FUND
                                        (INSTITUTIONAL), L.P.
                                        By: SMM Corporate Management, LLC,
                                            General Partner


                                        By:
                                            ------------------------------------
                                            Name: James C. Gale
                                            Title: Manager

      Signature Page to Second Amended & Restated Investor Rights Agreement
<PAGE>
     IN WITNESS WHEREOF, the parties hereto have executed this SECOND AMENDED
AND RESTATED INVESTOR RIGHTS AGREEMENT as of the date set forth in the first
paragraph hereof.

COMPANY:                                INVESTORS:

VALERA PHARMACEUTICALS, INC.            SMH HYDRO MED LLC


BY:                                      By: /s/ James C. Gale
    ---------------------------------       ------------------------------------
    Name: David S. Tierney                  Name: James C. Gale
    Title: President                        Title: Manager


                                        SMH HYDRO MED II LLC


                                        By: /s/ James C. Gale
                                            ------------------------------------
                                            Name: James C. Gale
                                            Title: Manager


                                        SMH VALERA LLC


                                        By: /s/ James C. Gale
                                            ------------------------------------
                                            Name: James C. Gale
                                            Title: Manager


                                        CORPORATE OPPORTUNITIES FUND, L.P.
                                        By: SMM Corporate Management, LLC,
                                            General Partner


                                        By: /s/ James C. Gale
                                            ------------------------------------
                                            Name: James C. Gale
                                            Title: Manager


                                        CORPORATE OPPORTUNITIES FUND
                                        (INSTITUTIONAL), L.P.
                                        By: SMM Corporate Management, LLC,
                                            General Partner


                                        By: /s/ James C. Gale
                                            ------------------------------------
                                            Name: James C. Gale
                                            Title: Manager

      Signature Page to Second Amended & Restated Investor Rights Agreement
<PAGE>
                                        LIFE SCIENCES OPPORTUNITIES FUND, L.P.
                                        By: SMH Life Sciences Management, LLC,
                                            General Partner


                                        By: /s/ James C. Gale
                                            ------------------------------------
                                            Name: James C. Gale
                                            Title: Manager


                                        WHEATLEY MEDTECH PARTNERS L.P.
                                        BY: Wheatley Medtech Partners LLC,
                                            General Partner


                                        By: /s/ David Dantzker
                                            ------------------------------------
                                            Name: David Dantzker, M.D.
                                            Title: VP

                                        WHEATLEY PARTNERS III, L.P.
                                        By: Wheatley Partners III, LLC,
                                            General Partner


                                        By: /s/ Barry Rubenstein
                                            ------------------------------------
                                            Name: Barry Rubenstein
                                            Title: CEO


                                        WHEATLEY ASSOCIATES III, L.P.
                                        By: Wheatley Partners III, LLC,
                                            General Partner


                                        By: /s/ Barry Rubenstein
                                            ------------------------------------
                                            Name: Barry Rubenstein
                                            Title: CEO

      Signature Page to Second Amended & Restated Investor Rights Agreement
<PAGE>
                                        WHEATLEY FOREIGN PARTNERS III, L.P.
                                        By: Wheatley Partners III, LLC,
                                            General Partner


                                        By: /s/ Barry Rubenstein
                                            ------------------------------------
                                            Name: Barry Rubenstein
                                            Title: CEO


                                        FALCON SEABOARD HOLDINGS, L.P.


                                        By: /s/ E.H. (Gene) Dewhurst
                                            ------------------------------------
                                            Name: E.H. (Gene) Dewhurst
                                            Title: Vice President-Finance
                                                   & Treasurer


                                        NJTC VENTURE FUND SBIC, L.P.


                                        By: /s/ Robert M Chefitz
                                            ------------------------------------
                                            Name: Robert M Chefitz
                                            Title: General Partner


                                        PSILOS GROUP PARTNERS II SBIC, L.P.
                                        By: Psilos Group Partners II SBIC GP,
                                            LLC, its General Partner


                                        By: /s/ Jeffrey Krauss
                                            ------------------------------------
                                            Name: Jeffrey Krauss
                                            Title: Managing Member

     SIGNATURE PAGE TO SECOND AMENDED & RESTATED INVESTOR RIGHTS AGREEMENT
<PAGE>
                                        PEQUOT SCOUT FUND, L.P.
                                        By: Pequot Capital Management, Inc.
                                            as Investment Manager


                                        By: /s/ Harold Kahn
                                            ------------------------------------
                                            Name: Harold Kahn
                                            Title: Principal


                                        PEQUOT NAVIGATOR ONSHORE FUND, L.P.
                                        By: Pequot Capital Management, Inc.
                                            as Investment Manager


                                        By: /s/ Harold Kahn
                                            ------------------------------------
                                            Name: Harold Kahn
                                            Title: Principal


                                        PALADIN LABS INC.


                                        By:
                                            ------------------------------------
                                            Name:
                                                  ------------------------------
                                            Title:
                                                   -----------------------------


                                        COMMON STOCK INVESTORS:

                                        GP STRATEGIES CORPORATION


                                        By:
                                            ------------------------------------
                                            Name:
                                                  ------------------------------
                                            Title:
                                                   -----------------------------

     SIGNATURE PAGE TO SECOND AMENDED & RESTATED INVESTOR RIGHTS AGREEMENT
<PAGE>
                                        PEQUOT SCOUT FUND, L.P.
                                        By: Pequot Capital Management, Inc.
                                            as Investment Manager


                                        By:
                                            ------------------------------------
                                            Name: Lawrence Cutler
                                            Title: Principal


                                        PEQUOT NAVIGATOR ONSHORE FUND, L.P.

                                        By: Pequot Capital Management, Inc.
                                            as Investment Manager


                                        By:
                                            ------------------------------------
                                            Name: Lawrence Cutler
                                            Title: Principal


                                        PALADIN LABS INC.


                                        By: /s/ Jonathon Goodman
                                            ------------------------------------
                                            Name: Jonathon Goodman
                                            Title: President & CEO


                                        COMMON STOCK INVESTORS:

                                        GP STRATEGIES CORPORATION


                                        By: /s/ Andrea Kantor
                                            ------------------------------------
                                            Name: Andrea Kantor
                                            Title: VP, General Counsel

     Signature Page to Second Amended & Restated Investor Rights Agreement
<PAGE>
                                   EXHIBIT A

                             COMMON STOCK INVESTORS

GP Strategies Corporation
9 West 57th Street
New York, New York 10019

                               SERIES A INVESTORS

SMH Hydro Med LLC
600 Travis, Suite 3100
Houston, Texas 77002
Attention: John Malanga

Corporate Opportunities Fund, L.P.
Corporate Opportunities Fund (Institutional), L.P.
c/o SMM Corporate Management LLC
126 East 56 Street
New York, New York 10022
Attention: James C. Gale

Wheatley MedTech Partners L.P.
80 Cuttermill Road, Suite 302
Great Neck, New York 11021

With a copy to:

Wheatley Partners
825 Third Avenue, 32nd Floor
New York, New York 10022
Attn: David R. Dantzker, M.D.
      Lawrence Wagenburg


                                       A-1
<PAGE>
                               SERIES B INVESTORS

SMH Hydro Med II LLC
600 Travis, Suite 3100
Houston, Texas 77002
Attention: John Malanga

Corporate Opportunities Fund, L.P.
Corporate Opportunities Fund (Institutional), L.P.
Life Sciences Opportunities Fund, L.P.
c/o SMM Corporate Management LLC
126 East 56 Street
New York, New York 10022
Attention: James C. Gale

Wheatley MedTech Partners L.P.
80 Cuttermill Road, Suite 302
Great Neck, New York 11021

With a copy to:

Wheatley Partners
825 Third Avenue, 32nd Floor
New York, New York 10022
Attn: David R. Dantzker, M.D./
      Lawrence Wagenburg

Wheatley Partners III, L.P.
Wheatley Associates III, L.P.
Wheatley Foreign Partners, III, L.P.
80 Cuttermill Road, Suite 302
Great Neck, New York 11021

With a copy to:

Wheatley Partners
825 Third Avenue, 32nd Floor
New York, New York 10022
Attn: Lawrence Wagenberg


                                       A-2
<PAGE>
Paladin Labs, Inc.
6111 Royalmount Avenue
Suite 102
Montreal, Quebec H4P 2T4
Attention: Samira Sakhia

Falcon Seaboard Holdings, L.P.
109 N. Post Oak Lane
Houston, Texas 77024

NJTC Venture Fund SBIC, L.P.
1001 Briggs Road, Suite 280
Mt. Laurel, New Jersey 08054

Pequot Scout Fund, L.P.
Pequot Capital Management, Inc.
500 Nyala Farm Road
Westport, CT 06880
Attention: Amber Tencic/Aryeh Davis

Pequot Navigator Onshore Fund, L.P.
Pequot Capital Management, Inc.
500 Nyala Farm Road
Westport, CT 06880
Attention: Amber Tencic/Aryeh Davis


                                       A-3
<PAGE>
                               SERIES C INVESTORS

SMH Valera LLC
600 Travis, Suite 3100
Houston, Texas 77002
Attention: John Malanga

Life Sciences Opportunities Fund, L.P.
c/o SMM Corporate Management LLC
126 East 56 Street
New York, New York 10022
Attention: James C. Gale

Wheatley MedTech Partners L.P.
80 Cuttermill Road, Suite 302
Great Neck, New York 11021

With a copy to:

Wheatley Partners
825 Third Avenue, 32nd Floor
New York, New York 10022
Attn: David R. Dantzker, M.D./
      Lawrence Wagenburg

Wheatley Partners III, L.P.
Wheatley Associates III, L.P.
Wheatley Foreign Partners, III, L.P.
80 Cuttermill Road, Suite 302
Great Neck, New York 11021

With a copy to:

Wheatley Partners
825 Third Avenue, 32nd Floor
New York, New York 10022
Attn: Lawrence Wagenberg

Falcon Seaboard Holdings, L.P.
109 N. Post Oak Lane
Houston, Texas 77024


                                       A-4
<PAGE>
NJTC Venture Fund SBIC, L.P.
1001 Briggs Road, Suite 280
Mt. Laurel, New Jersey 08054

Pequot Scout Fund, L.P.
Pequot Capital Management, Inc.
500 Nyala Farm Road
Westport, CT 06880
Attention: Amber Tencic/Aryeh Davis

Pequot Navigator Onshore Fund, L.P.
Pequot Capital Management, Inc.
500 Nyala Farm Road
Westport, CT 06880
Attention: Amber Tencic/Aryeh Davis

Psilos Group Partners II SBIC, L.P.
625 Avenue of the Americas, 4th Floor
New York, NY 10011


                                       A-5