China poses unique compliance challenges for pharmaceutical companies, with several well-known foreign companies getting caught up in corruption investigations in the past year. President Xi Jinping has publicly made fighting corruption one of his cornerstone policies. Additionally, the DOJ and SEC have been quite vocal in recent years about their ongoing Foreign Corrupt Practices Act (FCPA) enforcement focus on the pharmaceutical industry, with a particular focus on China. In recent years, 10 investigations under the FCPA involving alleged violations in China by pharmaceutical and medical device makers. Finally, it’s been long known that the structure of the healthcare system and environment in China creates a high-risk industry. So why, despite knowing these things, did certain pharmaceutical companies recently find themselves embroiled in corruption scandals?
Fundamentally, it comes down to the way business is done in China, the inherent lack of a proper funding mechanism for hospitals and doctors, which are largely state-owned, and the lack of a robust compliance program on the part of pharmaceutical companies (or a willingness to look the other way in the pursuit of revenue). Pharmaceutical companies have embraced the Chinese market and its risks as it was seen as a solution to weak sales growth in developed markets and reduced revenue due to competition from generic drugs.
Corruption risks are not limited to the healthcare industry. Any business that purchases from vendors or has sales and distribution networks will likely eventually face kickback issues. However, China’s healthcare industry is largely government owned, elevating the risk into the FCPA realm. Doctors are notoriously low paid (taxi drivers generally earn better wages than new doctors), and therefore are forced to seek alternative sources of income. The competition in this industry is fierce with many players being able to operate without having to be concerned with FCPA ramifications.
Therefore, given that backdrop, there are tremendous pressures on pharmaceutical companies and their employees to perform and opportunities to meet performance objectives that do not comply with western ethical standards and laws.
Given the above, pharmaceutical companies have a few options. They can engage in local business practices and hope that any crackdown is temporary, which is sometimes the case in China. In such case, companies take the gamble that the short-term pain is offset by the long-term gain. Many see the recent action by the government across several industries (pharmaceuticals, dairy products and television screens) as primarily a price reduction initiative. Once prices are reduced, the thinking is that further action will abate. However, if a company is unlucky enough to get caught up in a corruption/anti-bribery probe, one has to wonder whether the financial consequences, such as the substantial costs of conducting investigations and substantial penalties that can be imposed, and damage to a company’s reputation are worth the ultimate price it will pay in the end. The risks with this approach are substantial as foreign companies are easy targets for government-initiated crackdowns by the government in China, which can have a ripple effect triggering FCPA investigations by the U.S. DOJ.
Another option is to not enter China or leave if a company is already there. Actavis recently made the decision to exit China with its CEO stating that China “is just too risky” and “not a business friendly environment”, and hinting that it wasn’t a level playing field due to the uneven application of law, which allows certain companies a competitive advantage.
The third option is to understand the limitations and costs one has to endure to operate in the China market, accept certain unfair market realities, perhaps adjust the way products are sold in China and, finally, ensure that you have a robust compliance program in place. The American Chamber of Commerce in Shanghai recently released its 2013 – 2014 China Business report which indicates that just over 40 percent of the 400 American companies surveyed will increase spending on compliance programs over the next year. If a company wants to have an effective compliance program in China, particularly in a high-risk industry such as healthcare, it’s going to take considerable time, money and effort to continuously educate and monitor employees. A good training program should consist of the following:
Training
Employees must be provided extensive and continuous training to drive home that the company has zero tolerance for certain practices. Many employees will view certain practices prohibited by the FCPA, and Chinese anti-bribery laws, as essential to doing business. It is important for companies to explain in detail and provide examples of what is prohibited by the FCPA and Chinese anti-bribery laws, and explain the consequences for violating such rules, i.e. termination of employment and investigation by authorities.
Encourage Whistleblowing
Companies should encourage employees to come forward if they have any information regarding any violations, and have policies and programs in place to ensure such employees do not face retaliation for doing so. Often whistleblowers will flag schemes or behavior a company is unaware of, and will have access or insight to information that will be impossible to obtain through an investigation.
Continuous Auditing of Business Relationships and Financial Transactions
In the investigations conducted last year against several pharmaceutical companies, it was revealed that many of those involved had funneled money through travel agencies to hospitals and doctors. Employees are creative in coming up with arrangements to make illicit payments to obtain business. Companies must have compliance teams in place that can spot irregularities. In one case, the company was paying the travel agency millions of dollars a year, but the travel agency appeared to be doing very little work. In hindsight, this should have been an obvious red flag. Another common method is for employees to submit fraudulent receipts to obtain cash reimbursements to use for illicit payments. It is very easy to get such receipts in China so companies need compliance teams that can effectively control the reimbursement process.
Ultimately, it’s a business decision as to which option a pharmaceutical company wishes to pursue given the legal risks involved and potential business opportunities. However, it’s likely most would agree that the third option makes the best long term sense. A company just needs to carefully analyze whether it can compete effectively given the additional costs and business constraints it will face over certain competitors.
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