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Subpoenas at Medco and AstraZeneca Follow History of Kickback Settlements

Medco (MHS) and AstraZeneca (AZN) did not give much detail on why they received joint subpoenas from the Department of Justice today but AZ confirmed that it involves Prilosec and Nexium, its heartburn pills. Both companies said they could not quantify their potential liabilities in the matter but if history is any guide liabilities could reach into the hundreds of millions of dollars, making Express Scripts' (ESRX) planned acquisition of Medco for $29.1 billion more expensive and more complicated. (Pictured: Medco CEO David Snow and Express CEO George Paz.)

The subpoenas could well be related to rebates that AstraZeneca allegedly paid Medco to secure favorable positions on the pharmacy benefit manager's formulary over generic drugs. In October 2010, AstraZeneca lost an attempt to dismiss a whistleblower lawsuit brought by former Medco executive Karl Schumann, who handled contracting for the PBM.

His suit alleges that AZ paid $100 million to Medco in bogus fees for promotions, data management programs and educational grants that functioned as kickbacks to make sure Medco patients received Prilosec and Nexium instead of cheaper generics.

Part of the business model
The issue of AZ's rebates to Medco has been known since 2002, and has drawn federal attention before. They have historically been a significant part of Medco's business model, according to Lawrence W. Abrams, a PBM researcher:

For the first time in its 2007 10-K annual report to the SEC, Medco separated out client fees from so-called "data fees" received from Pharma. This separation was likely due to pressure for more transparency as many believe that "data fees" from Pharma are a surrogate for pharmaceutical rebates.
If the rebates and fees are not discounted off the price of the drugs being sold, then Medicare and Medicaid can end up over-paying for drugs. Two federal appeals courts have recently upheld cases that alleged rebates were illegal kickbacks in the drug business, reversing a chain of decisions that made kickback cases more difficult to bring.

Schumann alleges that from 1996 onward, AZ gave Medco $100 million in kickbacks in the form of "disease management" agreements to switch patients to Prilosec and Nexium. The companies stopped the scheme when the feds became interested in it, he alleges in his complaint:

In or around 2003, with concerns growing over the Government's ongoing investigations into shady PBM deals with drug makers (and Medco's deals, in particular) and the AstraZeneca Defendants' guilty plea and Corporate Integrity Agreement in the Zoladex case, Medco and AZ quietly disbanded the Disease-Management Agreement.
What did Brennan know?
Schumann also hints that AZ CEO David Brennan may have known something about the scheme:
AstraZeneca told analysts in October [2001] that ... AstraZeneca is less concerned about managed care as a source of pricing pressure than about govemment action. "We've had .... pricing pressures from the managed care organizations over the last several years and figured out how to deal with them," he said. "I think the issue that's more acute that we will be dealing with will be the federal issue around drug benefits and ... the public sector business."
In terms of Medco and AZ's liability, here are some numbers to consider:
  • Between 1996 and 2003 state Medicaid programs alone paid $3.4 billion for Prilosec and $2.5 billion for Nexium, Schumann claims.
  • The rebates were worth 6-15 percent of the price of the drugs, Schumman's suit says.
  • Nexium grossed $5.7 billion in revenues for AZ in the mid-2000s
  • In 2006, Medco paid $155 million to settle similar claims, also brought by Schumman.
  • Also that year, Omnicare (OCR), a smaller PBM, settled similar claims for $49.5 million.
  • In 2009, Omnicare settled another case on the issue for $98 million.
Fitch recently signalled it might downgrade Express Scripts' debt due to the Medco acquisition. Based on the above, it might want to run those numbers again.

Related: Image by Flickr user quaziefoto, CC.