2012 was not a good year for the pharmaceutical industry: GlaxoSmithKline — $3 billion settlement with United States over illegal marketing of nine different prescription drugs, including Wellbutrin, Paxil, and Avandia; Abbott Laboratories $1.5 billion settlement for off-label marketing of Depakote; Merck — $950 million settlement for illegal marketing of Vioxx; McKesson — $190 million settlement for inflating prescription drug price information; Johnson and Johnson — $158 million settlement for off-label marketing of Risperdal; Orthofix International — $43 million settlement for illegal marketing of a bond growth stimulation device and illegal kickbacks; Blackstone Medical — $32 million settlement for illegal marketing of a bond growth stimulation device and illegal kickbacks.  

The above settlements arose out of investigations for violations of the Federal False Claims Act (FCA). But the government is also pursuing cases involving violations of the Foreign Corrupt Practices Act (FCPA), and it may be the FCPA that poses the greatest threat to the pharmaceutical industry going forward, for example:

Pfizer/Wyeth LLC — $45 million settlement with the Securities and Exchange Commission (SEC) for illegal payments made by its subsidiaries to foreign officials in Bulgaria, China, Croatia, Czech Republic, Italy, Kazakhstan, Russia and Serbia to obtain regulatory approvals, sales and increased prescriptions for its products; Biomet — the SEC charged the Warsaw, Indiana-based medical device company with violating the FCPA when its subsidiaries and agents bribed public doctors in Argentina, Brazil and China for nearly a decade to win business. Smith & Nephew — $22 million settlement for bribing public doctors in Greece for more than a decade to win business.  

On December 20, 2012, Eli Lilly and Company (Lilly), a large manufacturer of pharmaceuticals, entered into a settlementi with the Securities and Exchange Commission in which it agreed to pay a total of $29 million to settle a claim that it had violated various provisions of the Securities and Exchange Act of 1934ii when it bribed foreign officials in Brazil, China, Poland and Russia for their assistance in obtaining orders for the purchase of Lilly’s drugs. While Lilly did not admit or deny the allegations, the complaint accuses Lilly’s management in Indianapolis of failing to insure that the real purpose of the expenditures was accurately reported in its books and records and of not having sufficient mechanisms to conduct genuine due diligence of its business partners in order to prevent monies from being used for improper purposes.  

The Lilly complaint should be mandatory reading for senior management of any company doing business overseas. The complaint describes the most common schemes used to circumvent the FCPA as well as the various errors by management that made it possible for the law to be violated in the first place. It also reveals management’s failure to take any meaningful steps to prevent further violations when first made aware that it had a problem. Indeed, in some respects the complaint is a more useful tool for understanding the requirements of the law than the Department of Justice’s Resource Guide to the U.S. Foreign Corrupt Practices Act.  

At its heart, the FCPA reflects a simple concept: A benefit provided a foreign official to get business or keep business is a crime. It doesn’t matter if you pay the foreign official money or give the official a gift. It doesn’t matter if you provide the benefit through a third party. If the foreign official wants something for his or her support and your company provides it, it is a crime. But like any crime, success depends upon concealment. In the case of Lilly, the SEC alleged a litany of methods used to conceal the bribes.

In Poland, it is alleged that Lilly tried to hide payments to a foreign government official by making donations to a foundation founded and run by the official. A total of $39,000 was paid to the Chudow Foundation in order to induce the director of one of the country’s health funds to purchase Lilly’s cancer drug Gemzar for its public hospitals and other health care providers. The success of this scheme depended upon Lilly inaccurately reporting the nature of its contribution on its books and records - a violation of Section 13(b)(2)(A) of the Exchange Act. Payments to the foundation were falsely described as for the purchase of computers, to support activities at the Chudow Castle and for conferences to be held at the castle. Ultimately, it was not difficult to uncover the true purpose of the contributions since they were paired with purchases of Lilly products, Lilly was not engaged in making any other charitable contributions in Poland and emails were discovered which openly discussed the purpose of the transactions  

Lilly’s operations in China may have been a bit more sophisticated. Salespersons, whose expenses were reimbursed by Lilly, were told to create dummy expense reports to give to their supervisors. The money obtained from the dummy reports was used to purchase gifts and entertainment for Chinese doctors including meals, trips to bathhouses, money for card games, and karaoke bars. The complaint does not reveal how the scheme was uncovered, but it did continue up through 2009 when business transactions with China came under greater government scrutiny. It could be that this scheme was discovered first, and the others uncovered during a comprehensive internal investigation of all the company’s operations.  

A different scheme was used in Brazil. There, Lilly sold its drugs to distributors at a discount. The distributors thereafter resold the drugs to the government at a higher price. The difference would be their profit. However, in two instances, a deeper discount was authorized and the distributor was able to use the additional money it received to pay off officials to secure the orders. Apparently, no one at Lilly questioned why it was selling its drugs to these distributors so cheaply. But again, the crime was apparent to anyone who looked closely at the books and asked a few simple questions.  

The least sophisticated scheme was in Russia, where Lilly simply paid third parties for “services” clearly provided by others. In some instances, no effort was made to even explain what services had been provided. In others, the descriptions were so ludicrous that they would never have survived the most minimal amount of scrutiny.  

The violations set forth in the complaint did not occur because of any ignorance of the law. The employees involved may not have known which law they were violating, but they knew enough to know their actions had to be hidden. In order to conceal the purpose behind Lilly’s expenditures, payments were falsely described as reimbursement of expenses in China. Payments were described in company records as a “discount” for a pharmaceutical distributor in Brazil. Payments were classified as charitable donation, which in fact had no genuine charitable purpose, in Poland. And in Russia, millions of dollars in payments were characterized as for various services not actually provided.  

Lilly’s management in Indianapolis cannot be excused from not knowing what its employees were doing overseas because Lilly had no meaningful controls to supervise its employees’ conduct. Lilly simply accepted assurances that its foreign intermediaries would not provide a benefit to a government official in order to secure business. Lilly had no independent means to verify any representations its foreign employees made concerning the relationship between intermediaries and foreign officials or the nature of the services being provided by intermediaries. Moreover, despite warnings that certain markets were particularly prone to fraud, Lilly took no steps to subject its business in those foreign venues to any greater scrutiny to insure compliance with the FCPA. It essentially ignored warnings by its own staff.  

Some might argue that a $29 million fine is just a cost of doing business for a company with billions of dollars of sales each year, and indeed that may be a justifiable criticism of this particular settlement. But it would be a mistake to see the Lilly settlement as an endorsement of employing a cost benefit analysis in deciding whether to obey the law. On December 19, 2012, Amgen agreed to pay $762 million to settle charges brought by the DOJ arising out of its marketing of off label uses for its various drugs.iii In Amgen’s case, it also pled guilty to a single misdemeanor count of misbranding. With the nomination of the former U.S. Attorney for the Southern District of New York, Mary Jo White, to be Chairman of the SEC, the administration has signaled its intent to have the SEC operate more like the DOJ, a development which would mean even stricter enforcement and higher penalties should she be confirmed.  

The takeaway from the government’s enforcement actions in 2012 is that companies can expect even more scrutiny in the coming year and not just for their domestic operations. Another important lesson is that compliance is critical. In declining to sanction Morgan Stanley for the violation of the FCPA committed by Garth Peterson, the Director In Charge of its real estate group in Shanghai, China, the Department of Justice relied on the fact that Morgan Stanley had a robust compliance program that frequently trained its employees and included safeguards intended to insure that no transactions occurred that would result in illegal payments to foreign officials.iv Of course, no compliance program can prevent an employee bent on breaking the law from trying to beat the system. But the DOJ has made it clear that a well thought out, well executed and management-supported compliance regime can make the difference between a settlement praising a company’s efforts and one that involves millions of dollars in disgorgement and civil penalties, lengthy terms of supervision and pleas to criminal charges.v