Tax Case Reveals Why Pills Cost So Much

 Miami Herald, January 12, 2009

Tax Case Reveals Why Pills Cost So Much
A Miami court case exposed secrets of the U.S. healthcare system — and why Americans must pay more for medicine.

In a court hearing last week involving the owners of the bankrupt Pharmed medical supply company, astonishing details were revealed about the dark underbelly of the pharmaceutical industry and how distributors often make Americans pay far more for drugs than people in other countries.

Attorney Dennis G. Kainen, representing one of the Pharmed owners, said the case exposed “the dirty little secrets of American pharmaceutical companies.”

As U.S. District Judge Patricia Seitz listened to the details, she wondered aloud if she was hearing about the “new robber barons.”

The information showed not only how fraud can increase healthcare costs, but how even legitimate companies force Americans to pay more. It came out during the sentencing hearing of Carlos and Jorge de Céspedes, who had pleaded guilty to tax evasion and using their Pharmed company to defraud Kendall Regional Medical Center out of $5 million.

During a three-day sentencing hearing, prosecutors maintained that the brothers deserved extra prison time because the $8 million that they had not paid in taxes was on money derived from criminal behavior. Defense attorneys said that was nonsense.

What followed was an intense discussion about the hidden pricing systems in the murky world — sometimes called the “gray market” — of pharmaceutical drugs.

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 for 90 40mg tablets in the United States, but can be had for $138 in India and $199 in Europe.

The healthcare industry vehemently defends its pricing. A spokesman for Pharmaceutical Research and Manufacturers of America, a trade group, says drugmakers need high prices in the United States because they finance almost $60 billion in annual research that develops breakthroughs for everything from cancer to AIDS.

Consumer advocates don’t buy the argument that Americans should pay more than others do. “It’s outrageous,” says Bernd Wollschlaeger, a North Miami Beach family physician. “We’re already having huge problems because our healthcare costs are so high. I just had a patient call up and say he can’t afford a prescription that would cost him $220. These costs prevent people from getting treatment.”

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.”

In fact, the companies did no marketing work, but simply transferred the money to a lawyer’s trust account. Some of it ended up with The Astri Group, the brothers’ venture capital company, and some went to pay for the de Céspedes’ personal living expenses, including luxury cars, Schlessinger said.

In all, $30 million from Roche slipped through these dummy corporations. Among other things, this maneuver cheated Pharmed’s minority shareholders out of their share of the profits, the prosecutor maintained. These shareholders, mostly other corporate officers, owned 11 or 12 percent of the company.

The brothers paid no taxes on about $22 million of the diverted money.

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.

All these shell companies and warehouses to shuffle money and drugs around were “clearly the proceeds of criminal conduct,” Schlessinger maintained.

Utterly untrue, responded Kainen, the attorney for Carlos de Céspedes. The brothers’ moving the drugs may have been a matter for civil litigation about contractual obligations, but was not criminal. In fact, Roche had never even filed a civil lawsuit against Pharmed.

Kainen 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.

The drugs were not out-dated, but major retailers, such as Walgreens, refuse to take drugs near their expiration dates because they don’t want the drugs getting old on their shelves.

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. In the sentencing hearing, Schlessinger eventually withdrew his statement that Roche had been defrauded, but he continued to maintain that the diverted $30 million had defrauded the minority shareholders out of about $3 million, their share of the profits.

Seitz concluded, “It’s clear a fraud did occur against the minority shareholders,” but it didn’t rise to the level that would have increased the brother’s jail time.

Still, 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.

The reason for multiple warehouses and deception is that makers of medical supplies often sell their products cheaper to hospitals than to other places.

Sometimes that’s because hospital groups have strong purchasing power and can negotiate better prices. Other times it’s because pharmaceutical companies want patients going home with their brand of drugs, meaning they’re likely to remain on that brand for future prescriptions.

“So there are many different price levels and rules,” said Joe Colonna, a consultant on medical-supply purchasing. “I’d say 95 percent of the industry is honest and trying very hard to do the right thing, but anytime you have lots of fee schedules and lots of rules, some people are going to figure out how to game the system.”

Because of that, some suppliers, such as Johnson & Johnson, have become cautious, providing rebates after a sale, rather than discounts before a sale, when a distributor proves that the goods have gone to a hospital.

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.

In the sentencing hearing, Seitz listened to the description about what had gone on with Roche — the dummy corporations and fake warehouses — and sighed that it seemed to be a case of the “winking and nodding that goes on in the capitalistic system these days.”