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Acquisition May Create Headaches for Merck in Foreign Corruption Probe

EDITOR'S NOTE: This is a revised version of an earlier BNET column. Merck objected to our characterizations of a Department of Justice and the SEC investigation in that article, and BNET regrets any errors or false implications.
Merck (MRK) disclosed in its quarterly 10-Q filing that it is the subject of an investigation by the Department of Justice and the SEC for possible violations of the Foreign Corrupt Practices Act (which prohibits paying bribes to do business in foreign countries). The investigation comes with a bit of unspoken history -- and some potential risk created by Merck's recent acquisition of Schering-Plough.

Merck says "this inquiry is part of a broader review of pharmaceutical industry practice." That's true: at least 10 other companies are suspected of doing the same thing, and an 11th -- SciClone (SCLN.O) popped up Tuesday.

However, the fuller context is that the letters are more serious than a "review." A DOJ assistant attorney general warned an assemblage of pharma industry lawyers last year that DOJ "will be intensely focused on rooting out foreign bribery in your industry." A similar criminal investigation has already led to the imprisonment of one executive at Johnson & Johnson (JNJ) in the U.K., and J&J admitted in its most recent 10-Q that it had violated anti-corruption laws and that investigations are under way in several nations, including the United States.

The U.S. investigation is ongoing, and Merck told BNET it's cooperating with authorities. While emphasizing that it has an FCPA compliance program in place, Merck's 10-Q says that the company has not been charged with any FCPA violations:

The company has received letters from the DOJ and the SEC that seek information about activities in a number of countries and reference the Foreign Corrupt Practices Act. The company is cooperating with the agencies in their requests and believes that this inquiry is part of a broader review of pharmaceutical industry practices in foreign countries.
Despite its public assurances and FCPA compliance programs, Merck nevertheless may have significant exposure in the investigation. The biggest source of vulnerability may be Schering-Plough, which Merck acquired in 2009. One ominous sign is that Schering-Plough has already been named in connection with an alleged foreign kickback scheme to promote the Hepatitis C drug PegIntron in Vietnam.

Schering-Plough stands accused of offering Vietnamese doctors a kickback of 10 to 30 percent of the medicine's price, according to Vietnam's English-language press. Vietnam's Health Ministry investigated those reports, and in March 2010, the prime minister demanded penalties be imposed on Schering for paying monthly commissions of $26,300 to doctors who prescribed PegIntron. One doctor at a medical school was rumored, according to the local press, to also be a marketing director at Schering.

As Schering's new parent, Merck assumes responsibility for any missteps Schering made prior to its acquisition.

While there's no evidence of wrongdoing at Merck, the company would not have needed to make the disclosure at all if it believed the probe would never become "material" to its financial statements. So what is the potential exposure? As the Vietnam incident suggests, the business practices of Schering-Plough prior to its acquisition by Merck stand out as a potential wildcard.

In response to BNET's queries about potential liabilities resulting from Schering-Plough's pre-acquisition business practices, Merck declined to comment beyond the statement contained within its 10-Q filing.

If prosecutors are not singling out Merck, and the letters they sent were just standard forms, then the matter could end with a simple reply to the feds' letters. On the other hand, companies found guilty of FCPA violations have been forced to disgorge the profits made from any corrupt scheme.

Either way there's a lesson in this experience for any company that seeks growth through acquisitions: You may get more than you paid for, and that's not always a welcome thing.

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Image by Flickr user neubie, CC.