Crackdown on Big Pharma
Regulators are striking back against a common strategy used by giant drug makers to block competition from generic companies.
NEW YORK (Fortune) -- For years, Big Pharma has kept competition from generic drug makers at bay by essentially paying its would-be rivals to stay out of its business. Now government watchdogs have declared war on these financial deals - a move that could bring cheaper drugs to market faster while costing giant drug developers billions in lost revenue.
Just last week the Federal Trade Commission launched a high-profile battle against Cephalon (CEPH), the maker of the blockbuster narcolepsy medication Provigil, over a $200 million payout it gave to four generic companies in exchange for an agreement not to develop a competing medication. In a lawsuit filed in federal court in Washington, D.C., the FTC claims that the deal violates antitrust law.
The deals behind the FTC crackdown have become increasingly common ever since Congress opened the door for generic drug competition in 1984. That's when a new federal law allowed generic drugmakers to challenge patents held by brand-name pharmaceutical companies in court. As these lawsuits grew in number, Big Pharma started to broker settlements whereby the generic companies agreed not to develop a competing drug in exchange for a onetime payment, often totaling millions of dollars. The FTC says there have been 100 deals like this since 2004.
Big Pharma and generic makers love them. Brand name developers get to protect their cash cows (it's estimated that sales of a brand name drug shrink by 80 percent in the first year after a generic version is released), while generic companies pocket a tidy sum without having to take on the high costs and risks of promoting a drug.
But regulators think these deals are illegal and have tried for years to get courts to agree - without much success. The way they see it, these patent settlements harm consumers because they prevent less expensive drugs from coming to market quickly. Americans spend more than $286 billion dollars on prescription drugs each year, according to the IMS Health market research group. Generics make up 65 percent of all prescriptions, but are roughly 20 percent of the costs. On average, generics cost nearly two-thirds less than their brand-name rivals.
So far regulators haven't had much success reining in these patent settlements. Only two of the nation's 11 federal circuits have declared these patent settlements unlawful. Last year, the U.S. Supreme Court refused to weigh in when it sided with AstraZeneca (AZN) in a government lawsuit challenging a $21 million deal it struck with Barr over the cancer treatment tamoxifen. Meanwhile, a Senate committee last week approved a bipartisan bill that would prohibit brand-name drug manufacturers from using settlement agreements to keep generic equivalents off the market. The full Senate has not scheduled a vote on the measure. Similar legislation is pending in the House of Representatives.
The practice is also under scrutiny overseas. The European Commission recently began investigating AstraZeneca, GlaxoSmithKline, Johnson & Johnson (JNJ, Fortune 500), Merck (PFE, Fortune 500), Pfizer, and Sanofi-Aventis (SNY) for similar payments to generic makers.
Big Pharma argues that a sweeping ban on these patent settlements would stifle innovation in the drug industry. Ken Johnson, senior vice president of Big Pharma's powerful lobbying apparatus, PHRMA, insists too that a prohibition is unnecessary given that the FTC and others have the authority to challenge individual deals. "The courts and enforcement agencies like the FTC are in the best position to review these settlements on a case-by-case basis to ensure that they are not harmful to competition," said Johnson.
But the FTC's goal behind last week's Cephalon lawsuit isn't a narrow victory. The agency is hoping the Supreme Court will eventually take up the case and issue a precedent-setting decision in its favor. "We're trying to reverse the course of the law and get another circuit to find these deals illegal in the hopes that the Supreme Court will resolve [the issue] once and for all," said an FTC staff member.
The government's case against Cephalon centers on a 2006 deal to keep a generic version of Provigil, which treats sleepiness in patients with narcolepsy and other disorders, off the market. Four generic drug makers - Teva (TEVA) Pharmaceutical Industries, Barr Pharmaceuticals, Ranbaxy, and Mylan - had agreed to drop lawsuits challenging the validity of Cephalon's Provigil patent until 2012 in exchange for a total of $200 million. Wall Street applauded the deal, which protected a drug that was responsible for 44 percent of Cephalon's $1.7 billion in 2006 revenues.
In its legal filing, the FTC claims that the settlement violates antitrust law and asks the court the issue a permanent injunction that would effectively allow generic versions of Provigil to come to market much earlier than 2012. Cephalon denies any wrongdoing. 
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