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How to make pharma companies into law abiding citizens

Last summer UC Berkeley professor Robert Reich reflected on the $3 billion penalty GlaxoSmithKline (GSK) paid for a whole range of violations.

Last summer UC Berkeley professor Robert Reich reflected on the $3 billion penalty GlaxoSmithKline (GSK) paid for a whole range of violations.  Their criminal behavior that led to the fine included: promoting an antidepressant approved only for adults to kids under 18; selling two other antidepressants for unapproved purposes, including sexual problems and; currying prescriptions by lavishing physicians with expensive gifts.

Professor Reich correctly noted that seemingly large fines such as this or the $2+ billion Pfizer paid a few years earlier won't deter pharma's criminal behavior.  GSK sold $27.5 billion worth of the three anti-depressants during the years of their malfeasance and, besides, shareholders pay the fines anyway.  The managers who devised and supervised the illegal behavior didn't have to pay a dime and they weren't hauled into criminal court.  In the unlikely event some shareholders attempt to chastise them, the disparity between the amounts of revenue and the penalty enable them to rationalize the fine as a mere cost of doing business.

Skepticism about the deterrent value of fining pharma companies is well placed.  Since the middle of last year, several more entries have appeared on this police blotter for pharma crime.  Each case was resolved with a pharma paying a fine in the hundreds of millions or the billions, yet the violators keep adding to the industry's rap sheet.  After Professor Reich predicted the GSK wouldn't lead to less law breaking, Amgen and Johnson & Johnson were nabbed for rigging the erythropoietin market (see here and here), Johnson & Johnson paid another $1.2 billion for bribing to push Risperdal sales, GSK faked a citizen petition, Pfizer acknowledged bribing foreign physicians, as well as a raft of other illegal practices.

Professor Reich recommends an additional sanction of holding pharma executives personally liable for continuing patterns of criminal conduct that the company commits under their watch.  That can help and, perhaps, a version of Sarbannes-Oxley applied to marketing and sales may deter some of the crime currently ignored in the executive suites.  As applied to financial scams, companies must establish independent processes to monitor its affairs and senior executives need to regularly attest that their review of financial matters reveals no improprieties.  If something along the lines of an Enron or a WorldCom later emerges, the execs know their country club buddies will see them taking perp walks on the news.

Now that may rectify things on matters of financial chicanery because criminal misconduct there can destroy an entire company.  On the marketing and sales side, however, the downside risks rarely rise to that level.  Two additional approaches can help change that calculus and create a deterrent with some teeth.

First, if a company makes $27.5 billion from products whose sales have benefitted from illegal marketing, it should be required to disgorge all profits that were booked on those brands during the period the transgressions occurred.  If senior managers know that the company's earnings, which drive their personal compensations, will face serious reversals, they'll think twice about winking at some off-label marketing.  If the company is forced to disgorge those profits, then shareholders who fail to receive their dividend checks will do the government's work of bouncing the white collar criminals.

There's another penalty to help pharmas follow the law.  Patent protection constitutes the bedrock of branded pharmaceuticals.  Without it the entire structure will crash to the ground.  Law abiding behavior by senior executives would receive another strong encouragement if they knew that they would lose patent protection for at least two years on any product that benefitted from off-label marketing or similar violations.  The blockbuster sales and the fat margins would go out the window and, with them, the exorbitant, eight-figure compensations for the miscreant executives.  (Lest anyone think such huge payouts are a thing of past, see here and here.)

Free marketers and capitalist cheerleaders should encourage the adoption of these three measures.  All are based on assigning personal responsibility and a careful weighing of the "hedonistic calculus" that underlies private enterprise.  Unfortunately, the rabid enthusiasts of private enterprise also maintain a reflexive hostility to any measures associated with government.  This leads most of them to reject a vigorous application of the law to white collar crime, even though it represents a logical extension of their economic premises.

One example of a private enterprise cheerleader at such cross-purposes with himself is John Mackey, the CEO of Whole Foods.  Mackey's libertarian rejection of government conflicts with his socially constructive view of capitalism.  In his recent book, Conscious Capitalism, Mackey espouses the purpose of private enterprise as "creating value for [interdependent] stake holders, including the community," rather than maximizing profits.  Money, he claims, "is a tool. It's not a destination.  It's a vehicle...If you produce money it's because you've created value for others."  This process of creating value for the society, in his opinion, "is at the essence of the conscious capitalistic company.  It's not an add on."  In this crucial way, Mackey stands in direct contrast to Milton Friedman, Friedrich Von Hayek, Ludwig Von Mises and other apostles of the greed-is-good faith.

Alas, if business operated with the conscious goal of creating a social benefit, the world would be a finer place.  Taking things as they are, however, the pursuit of profit varies between being the most important goal and the only goal at most companies.  Despite holding up such a noble purpose for business, Mr. Mackey is loathe to see government intervening to curb the worst excesses of companies that pursue profit at the community's detriment.

One might understandably ask what Mr. Mackey considers to be the two worst economic sectors in terms of pursuing profit instead of creating value?  Pharmaceuticals and investment banking take his booby prize (see here and here).  He believes corporations in those sectors "primarily exist to maximize the compensation of their executives and, secondarily, shareholder value rather than value creation for customers, employees, and other major stakeholders."

The pharmaceutical industry's engine of value creation is its R&D.  When that can no longer make major advances to the various standards of medical care, pharma relies on marketing and sales, financial legerdemain, political bribery and, ultimately, criminal cheating.  By vigorously applying the criminal law, the government can reduce the illegal approach.  The other three strategies can only go so far to enhance profit-making, so by shrinking the criminal end-game, the government can help turn pharma back to its highest and best social purpose.