Some major health care companies have been questioned by a state prosecutor taking aim at Medicaid fraud.

This month, both Merck ( MRK) and Cardinal Health ( CAH) revealed that they have fielded subpoenas from Illinois Attorney General Lisa Madigan. Merck said the prosecutor asked for information "related to repackaging of prescription drugs."

Then Cardinal issued a similar announcement, saying Illinois had begun "examining whether the company presented or caused to be presented false claims for payments to the Illinois Medicaid program related to repackaged pharmaceuticals."

Drug manufacturers such as Merck sell much of their supplies to three major distributors, including Cardinal, that operate drug repackaging arms. Those repackaging units break down bulk supplies and sell the drugs to pharmacies in more manageable quantities.

Now, Madigan seems to be questioning the big players in the drug supply chain.

Cardinal has portrayed its own repackaging unit, National PharmPak, as the largest operation of its kind. Competitors AmerisourceBergen ( ABC) and McKesson ( MCK) run giant repackaging units as well. During its investor day last year, AmerisourceBergen said the company's American Health Packaging division has "exceptional relationships" with 14 of the 17 largest brand-name drug manufacturers. Similarly, McKesson has said in the past that its own Rx-Pak division handles more than 175 different brand-name drugs.

"We do not believe Cardinal is the target of the investigation at this point," J.P. Morgan analyst Lisa Gill wrote after the company disclosed the investigation earlier this month. "We believe the subpoena serves a fact-finding purpose, and we expect others in the pharmaceutical channel to receive similar subpoenas."

In the meantime, Merck and Cardinal have said very little about their own subpoenas. Merck spokeswoman Amy Rose simply confirmed that the company had "received a subpoena, responded to it and is cooperating with the investigation." Cardinal didn't return phone messages from TheStreet.com seeking further elaboration on Tuesday. Neither AmerisourceBergen nor McKesson said whether they have been questioned by Madigan.

Track Record

Madigan has caused a stir by pursuing some other big health care companies already.

Back in January, the Chicago Tribune reported, Madigan subpoenaed Caremark ( CMX) -- a giant pharmacy benefit manager -- for allegedly reselling drugs that had been returned through the mail. Illinois has since replaced Caremark, which has denied any wrongdoing, with a competing PBM.

Then in February, Madigan joined 19 other states in suing 48 drug companies for allegedly overcharging government insurance programs. Merck is among those named in the complaint. Merck has managed to dismiss a class action lawsuit involving similar allegations, according to its latest annual report, and says it plans to "vigorously defend" itself against other pricing complaints.

Madigan is seeking millions of dollars in restitution under applicable state laws. She has embraced the state's whistleblower law, in particular, which allows for triple damages.

"The state False Claims Act has been around for a while," says Chicago attorney Ronald Schwartz. "But Lisa Madigan has really brought the resources to the table to enforce it. It has been a very conscious act."

Patrick Burns, a spokesman for Taxpayers Against Fraud, applauds that move. He says that Illinois has now joined a few other states -- notably California, Florida and Texas -- that have become known for cracking down on health care fraud.

"Illinois has been innovative and aggressive," Burns says. "It has a pretty strong False Claims Act bar, too. And they're all working together."

Hefty Tab

At the end of last year, Illinois counted 1.8 million residents -- or 14% of its population -- on the Medicaid rolls. The state, the nation's fifth most populous, picks up the drug tab for all of them.

Last year, the Kaiser Foundation estimated, that bill came to $1.5 billion. Only four states -- California, Texas, New York and Florida, the ones bigger than Illinois -- paid more.

Looking ahead, Illinois expects its own Medicaid drug bill to grow by a whopping 21% this year. Like other states, however, it will be looking for ways to keep that spending under control.

The Kaiser survey highlights the strategies tried so far. For example, it says, states often use preferred drug lists, generic substitution and manufacturer rebates in order to save money. Even so, it notes, Medicaid drug spending continues to rise at a double-digit clip every year.

Madigan, for one, intends to get some of that money back. She said as much when suing the 48 drugmakers for allegedly inflating their "average wholesale prices" earlier this year.

"Drug companies have manipulated the average wholesale prices and used these prices to overcharge state and federal government programs, taxpayers and Medicare consumers," she said. "We allege that this scheme is deceptive and illegal and has cost the state government and Medicare consumers millions of dollars."

Given the recent subpoenas, some people now believe that Madigan could be attacking the drugmakers -- along with those who supply their goods -- from another angle as well. Even Gill foresees the possibility of a sweeping new probe.

"The Cardinal investigation is still in its early stage," concedes Gill, who continues to maintain her overweight recommendation on Cardinal's shares. But "we believe the investigation is part of an industrywide investigation."

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