Roche Fraud Case Exposes Corruption Encouraged by Drug Pricing Politics

Roche has emerged as both victim and enabler in a big corruption case whose basis was the arcane pricing policies of U.S. drugs. In the case, two brothers who ran a medical supplies company were sentenced to nine years in prison for skimming contracts and avoiding taxes.

They had contracts with Roche, Johnson & Johnson and Wyeth to take drugs and supply them to hospitals. However, because drug companies charge different prices in different countries, the brothers were able to divert cheap pills bound for Puerto Rico and sell them to U.S. pharmacies, keeping the markup (and ripping off Roche).

The price differences exist because drug companies have lobbied for them. Consumer advocates want the U.S. ban on importating drugs ended so that drug prices will be forced into international price competition.

The Miami Herald has done a wonderful job of detailing the case. Rather than summarize it, I've digested it here with a focus on drug pricing and the role of Roche, J&J and Wyeth. It's an eye-opener.

In August 2004, Roche Healthcare abruptly stopped using Pharmed, resulting in the company losing $300 million in annual revenue. Roche gave no explanation for its move, but in recent court testimony it was revealed that a Roche audit discovered the brothers had been engaging in a complex plot that used Roche supplies in violation of their contract.

About the same time, Pharmed's original supplier, Johnson & Johnson, also ended its relationship with the brothers, accusing them of ''unjust enrichment'' in collecting $22 million in rebates to which they were not entitled.

Assistant U.S. Attorney Stephen Schlessinger told Judge Seitz that in 1999, Roche agreed to let Pharmed distribute its supplies, but only outside the United States. The cost of the drugs was low because Roche, like most companies, sells its drugs considerably cheaper in other countries, either because those countries have rigid price controls or because consumers in poor countries can't afford U.S. prices. One example: The highly popular Lipitor, a Pfizer product which fights cholesterol, costs $392 at Drugstore.com for 90 40mg tablets in the United States, but can be had for $138 in India and $199 in Europe.

In the Roche case, Pharmed honored the contract by shipping the drugs to a warehouse in Puerto Rico, a major distribution spot for goods going to the Caribbean and Latin America. But the Roche supplies didn't wind up there. Instead, they were forwarded to a Pharmed warehouse in Delaware, where they were resold to American customers at U.S. prices, allowing Pharmed a huge profit and ''systematically violating its contract'' with Roche, the prosecutor said.

Meanwhile, both prosecutors and defense attorneys agree, the brothers were skimming 2.5 percent of all the money received from Roche and transferring it to three dummy corporations for ``marketing expenses.''

Their plan unraveled in 2004, after a Texas company that had bought Roche drugs through Pharmed told Roche it wanted to return some of the supplies -- confirming that Pharmed's Roche products were ending up in the United States. Roche auditors visited Pharmed and verified the diversion. Roche immediately ended its relationship with Pharmed, which caused a loss of $300 million in annual revenue.

Roche had never even filed a civil lawsuit against Pharmed.

Kainen [the brothers' attorney] suggested in court that Roche may have avoided airing the matter in public because it would reveal that it was ''gouging the American public'' by charging high prices for drugs.

What's more, Kainen said the brothers had told him that a Roche national sales manager knew all about the drug diversion. Roche went along with the scheme because at the end of each month or each quarter it needed to move supplies that were nearing their expiration date, and ''Pharmed was always willing to take the product,'' the defense attorney said.

It was only after a ''corporate culture change'' at Roche that the company decided not to permit such contract abuses, the defense attorney told the judge.

Roche's director of public affairs, Darien E. Wilson, responded in an e-mail: ``The defense attorney statements regarding Roche are absolutely and categorically false. It is important to note that Roche cooperated fully with and supported the IRS for several years in its investigation into Pharmed. We also cooperated with the U.S. attorney's office, providing complete information.''

Ultimately, no criminal charges were filed against the brothers in the Roche drug diversion.

... the gray market maneuvering is something that has come up several times before with Pharmed, which collapsed in bankruptcy in October 2007 after losing its contracts with Roche and Johnson & Johnson.

Back in 1987, Wyeth Pharmaceuticals sued the brothers for using shell companies to improperly obtain drug discounts. That case was settled out of court. In 1999, AmerisourceBergen, a large medical supply wholesaler, sued Pharmed, accusing the company of setting up a shell company and warehouse a few miles from its main facility for the purpose of obtaining improper discounts. That case, too, was settled for an undisclosed amount.

In the fraud against Kendall Regional Medical Center, the scheme at first had co-conspirators in the hospital submitting orders to Pharmed only for J&J products -- products that the hospital paid for but were never delivered.

Why focus on J&J since the transactions were utterly fictitious? Because Pharmed received rebates from J&J for goods sold to hospitals. Eventually, J&J decided something was wrong. It accused Pharmed of taking $22 million in rebates that it was not entitled to. That case was settled in arbitration. The results are not known.