Gray Clouds Imperil Drug Firms

A lawsuit says AmerisourceBergen sold tainted drugs from the so-called gray market.
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Kevin Fagan had never heard of

AmerisourceBergen

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-- let alone seen the company's escalating stock chart -- when he said his teenage son received counterfeit medicine supplied by the giant drug distributor.

Fagan's introduction to the mysterious world of drug middlemen would come two months later. Fagan first had to watch his son suffer through agonizing spasms after taking medicine bought at a local

CVS

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pharmacy that was supposed to help him recover from a life-saving liver transplant. He felt stunned when he finally learned that his son's medication, obtained by AmerisourceBergen after passing through the shady gray market, was a low-dose fake at best.

Three years later, Fagan is still waiting for AmerisourceBergen to explain how the company wound up with what he calls tainted drugs -- and to offer some reassurance that it won't happen again.

"It's just mind-boggling," he says. "It seems like their established way of doing business. ... And, incredibly, the only person who has had to pay a price is my son."

If so, that situation could change. Fagan has sued AmerisourceBergen in a ground-breaking case that seeks damages from a big wholesaler for supplying counterfeit drugs to the public. Amerisource denies it acted improperly and says it will defend itself vigorously. But New York Attorney General Eliot Spitzer this spring subpoenaed the so-called Big Three wholesalers -- AmerisourceBergen,

Cardinal Health

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and

McKesson

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-- about their involvement in the gray market. In addition, Fagan's son has become the poster child for a new bill in Congress designed to crack down on counterfeiters and those who do business with them.

To be fair, the Big Three buy the vast majority of their drugs directly from manufacturers and purchase only a tiny fraction from secondary suppliers dealing in the loosely policed gray market. Moreover, all three claim they now buy even fewer drugs on the secondary market than they once did.

AmerisourceBergen, for example, says that it purchases "less than one-half of 1%" of its drugs -- and no high-risk medications -- from sellers other than manufacturers. In addition, the company says that it has strict guidelines in place for the authorized distributors it does use and, by now, has gone a full three years without counterfeit drugs entering its system.

Still, some question why the giant wholesalers -- trusted with roughly half of the country's drug supply -- expose themselves to the gray market at all. Critics of AmerisourceBergen, in particular, think they know the answer.

"The wholesale drug industry is run at high volumes with razor-thin 1% profit margins," states a shareholder derivative lawsuit, filed last year after AmerisourceBergen lost its biggest customer following a scandal involving the secondary market. But "if a large wholesaler like Amerisource can purchase drugs for less than the manufacturer's price on the gray market, the spread goes straight to the bottom line -- making the company appear more profitable in the short run but resulting in tremendous potential liability" in the end.

AmerisourceBergen's stock, which peaked above $80 the summer Fagan's son received contaminated drugs, plunged below $50 after the company lost its giant contract with the Veterans Administration two years ago. The stock has since recovered much of that ground, however, ending down 29 cents to $74.38 on Thursday.

Invisible Victims

Fagan's son, Tim, was supposed to receive a powerful and expensive form of the anti-anemia medicine Epogen following his liver transplant. But he claims he wound up with a tainted and far weaker version, re-labeled in the secondary market, instead.

Counterfeiters, charging thousands for boxes of weak Epogen that should have cost hundreds, clear millions through such deals.

"The drugs most commonly trafficked in by secondary wholesalers are some of the most expensive made today," a Florida grand jury wrote two years ago in a scathing report on the drug supply chain. And "the potential profits available to corrupt wholesalers rival those found in narcotics trafficking."

Fagan's son was lucky, surviving the ordeal. But his New York City attorney, Eric Turkewitz, believes that most victims fare much worse.

For one thing, Turkewitz explains, the victims unknowingly destroy evidence of a crime when they take their counterfeit medications and throw the containers in the trash. For another, he says, they face difficulties proving that the fake medicine hurt them -- if they even realize it -- because they are often sick with serious illnesses, such as AIDS or cancer, already.

By sheer chance, Turkewitz says, the Fagan family happened to save a bottle that once contained Epogen that he says was later proven to be fake.

"The chances of that happening are astronomically small," he says. "That's probably why Tim has one of the few cases out there, despite tens of thousands -- or even hundreds of thousands -- of victims."

AmerisourceBergen spokesman Mike Kilpatric says the company feels bad about Fagan's ordeal but continues to believe that his claims are without merit.

Regardless, Turkewitz is seeking huge punitive damages from AmerisourceBergen in an effort to keep the company from trading in the risky gray market again. A federal judge last summer rejected AmerisourceBergen's argument that the court should throw out the case, finding the company "in the best position to protect against the risk of harm," and cleared the way for a jury trial next year.

"My objective is to make sure that trading in the secondary market is no longer profitable. This industry," Turkewitz concludes, "has got to change."

Dodge Ball

Of course, the industry has escaped major changes in the past.

Notably, drug wholesalers have managed to block a federal law requiring so-called pedigree papers -- tracing medications from one supplier to the next -- that was passed more than 15 years ago. They have argued that pedigree papers would cost too much, trigger drug shortages and -- because they can be forged -- fail to eliminate counterfeit drugs in the end. And the Big Three, in particular, have insisted that they have strict controls in place to protect against counterfeit drugs on their own.

But AmerisourceBergen itself has confessed that problems can still arise. Moreover, the company has insisted that it should not be held accountable when that sometimes happens.

AmerisourceBergen presented its argument four summers ago when fighting a $2,000 fine for conducting business with an unlicensed wholesaler in Florida.

"The best Bergen can do in its dealings, negotiations and contractual arrangements with suppliers is to insist on and require compliance with all laws," Nicholes Ghnouly, legal counsel for what was then known as Bergen Brunswig, wrote to Florida health officials at the time. "Anything beyond that, which requires Bergen to actively police its suppliers and actively monitor their compliance with such laws, is administratively prohibitive."

The company then went on to argue that it would need to hire "numerous personnel whose sole task would be to do nothing other than sit in front of a computer all day," checking out other suppliers, in order to comply with the law.

Katherine Eban, author of

Dangerous Doses: How Counterfeiters Are Contaminating America's Drug Supply,

finds such claims ironic. After all, she points out, the giant drug distributors have always insisted that they purchase just a fraction of their drugs from the secondary wholesalers they would be expected to monitor.

The Florida grand jury has attacked the industry's argument as well.

"The industry puts forth the assertion that verifying and passing on pedigree papers would be so costly and time-consuming that their operations would cease or they would go bankrupt," the grand jury states in its 2003 report. "We believe this claim is absurd. ... If oyster harvesters and metals recyclers can do what is required of them, then we believe that drug wholesalers -- who handle approximately $93 billion of pharmaceutical products nationally -- can come up with a methodology to authenticate the products they are buying and selling."

Back Door

In the meantime, however, giant drug distributors continue to trade in the secondary market without that extra documentation.

AmerisourceBergen offered its reasons for doing so in an April regulatory filing that disclosed Spitzer's investigation. The company said that it purchases drugs from alternative sources when the drugs are in short supply -- "and, in some cases, to improve its margin" -- but stressed that it deals with fewer than 20 licensed wholesalers that are required to obey its product integrity program.

Since that filing, competitor Cardinal has actually closed its secondary trading division. But critics stress that the company, nevertheless, continues to buy drugs in the secondary market. Cardinal didn't return calls seeking comment.

"Cardinal said, rather loudly, that they were going to close the trading division that buys drugs from the secondary market," Eban told

TheStreet.com

. "What that means is that they've closed one of their back doors -- the back door that's marked 'back door.' But there are other, unmarked back doors that are still open."

Still, the industry could feel itself come under increasing pressure to close those doors in the future. Already, pharmacy giant

CVS

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has publicly announced that it will no longer do business with drug distributors that trade in the secondary market. And companies like FFF Enterprises, which pledges to buy drugs only from manufacturers and sell them only to end suppliers, are more than happy to step in and take over.

FFF Enterprises CEO Patrick M. Schmidt estimates that his company's business has grown by 50% over the past two years -- as awareness of counterfeit drugs has increased -- and continues to expand at a rapid clip. He portrays his company as unusual, for now, but expects others to follow its lead.

"If things stay the same and we continue to see counterfeit drugs -- and there's no reason to believe we will not -- then I think there will be a forced migration to this business model," Schmidt says. "I think that changes are absolutely coming" in the future.

Indeed, several outside forces are pushing the sector already. For one thing, Fagan's case could -- for the first time ever -- leave a drug wholesaler liable for counterfeit products. For another, Spitzer's investigation could uncover more counterfeit scandals that lead to mandated industry reforms. And for yet another, "Tim Fagan's Law" could overcome long odds, fueled by powerful industry lobbyists, to gain bipartisan support and actually pass in Congress.

In the meantime, the state of Florida -- once an outright haven for crooked drug wholesalers -- has already taken action by passing a tough counterfeit law of its own. Moreover, it has offered some harsh words of criticism for even legitimate wholesalers in the process.

"The fact that ... criminals act with such callous disregard for human suffering is immoral and despicable, but we find that others involved in the industry bear responsibility by turning a blind eye to this activity for the sake of profit," the Florida grand jury has stated. "Counterfeiters and re-labelers simply wouldn't be in business if they did not have a steady supply of willing buyers in the marketplace."

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