(FORTUNE Magazine) – Springtime on the plains of Midland, Texas, is an asthmatic's nightmare. Along with the tumbleweed and dust, there's always too much pollen floating in the wind. Alexis Milmine feels a stirring in her chest sometimes as often as four times a day. Her lungs tighten. Everything seems to come to a halt. Then comes the sharp pain, the one that feels as if someone is tap-dancing on her chest. She can breathe in just fine; it's exhaling that becomes a problem. "It literally takes your breath away," says the 17-year-old Milmine, who for as long as she can remember has been able to take two puffs of her trusty Proventil inhaler to thwart oncoming attacks of acute asthma. That is, until one day three years ago, when the medicine--made by Schering-Plough--seemed to lose its potency.

In the spring of 1999, Milmine would sense an attack coming, take two hits from her inhaler--and nothing. No effect. The symptoms would sometimes develop into a full-blown episode. Her doctor suggested taking four puffs at a time. Still nothing. One afternoon, at school, Alexis's friends watched her convulse as her inhaler failed her yet again. Her lips turned pale blue. Fearing that Milmine had developed a more severe illness, doctors ran a battery of expensive tests. The results were inconclusive. It wasn't until months later that the mystery unraveled. Milmine's grandmother saw a brief report on the evening news: Schering-Plough had issued a product recall on 59 million inhalers, many of which failed to contain the active ingredient.

Alexis Milmine might not have been so angry about her dud of an inhaler, she says, if she and her mother, Karen--who also suffers from asthma--weren't spending more than $2,000 a month on respiratory drugs. "I was in shock," she says. "We're paying all this money, and they're supposed to be selling something that helps me. I felt like they really needed to be looked at." After some research on the FDA's website, Milmine, just 14 at the time, wrote heated letters to the agency. She also wrote her Congressman, Larry Combest.

A handful of missives from a precocious teenager might not seem the sort of thing to provoke a Washington frenzy, but someone at the Justice Department caught wind of Milmine's complaints. By late summer 2001, Attorney General John Ashcroft was on the telephone with Alexis and her mother, asking if they would take part in congressional hearings on Schering's manufacturing troubles. The hearings had been tentatively set for autumn 2001, but were postponed indefinitely after the Sept. 11 terrorist attacks.

It's a strange twist of fate that a feisty teen might have a hand in Schering-Plough's unfolding crisis. In 1908 it was another enterprising adolescent, 16-year-old Abe Plough, who founded the company. Corporate lore has it that the young Plough borrowed $125 from his father, bought a horse and wagon, and began selling homemade remedies to farmers on the roads around Memphis. By the time Abe was 30, Plough Inc. had acquired and developed St. Joseph's children's aspirin. In 1971, Plough merged with Schering, which traces its roots to mid-19th-century Germany. A wholly American company by the 1940s, Schering adopted a growth-through-innovation strategy, and within a decade its researchers had developed leading antihistamines, antibiotics, and intestinal-infection treatments. These days there's at least one Schering product in every aisle of the local drugstore. The Kenilworth, N.J., company, with $9.8 billion in annual revenues, still specializes in research- intensive allergy and respiratory drugs, and anti-infection, cancer, and cardiovascular treatments. It also markets consumer items like Dr. Scholl's insoles and Coppertone and Bain de Soleil sun-care products. In addition, the company has a $700-million-a-year animal health-product business.

Disciplined manufacturing had always been a cornerstone of Schering-Plough's operations, but during the past five years the company has experienced a string of manufacturing stumbles so severe that it has faced product recalls, FDA fines and sanctions, and now a criminal investigation. Schering-Plough executives refused to comment for this story and have never publicly explained their operating difficulties. But sources close to the company say most of the problems stem from the U.S. introduction in 1993 of the blockbuster allergy drug, Claritin. With Claritin, Schering knew it had a monster hit, and it poured money and resources into sales and marketing as never before. That caused Schering to delay upgrading its plants, the sources say, a shortcoming compounded by a certain overconfidence in the durability of the company's manufacturing systems.

Schering's inhaler recall, which was ordered in September 1999 and then again in March 2000, marked the first time the public would hear about the company's manufacturing missteps. But the FDA had been looking into them at least as early as 1998. Between then and 2000, FDA inspectors visited Schering facilities in New Jersey and Puerto Rico 13 times. Those inspections resulted in at least five warning letters to the company, all of which chided executives over manufacturing deficiencies at four plants where some 90% of Schering's U.S. products are made. Among other violations, Schering, according to the FDA, failed to conduct required quality-control studies. When it did do the proper studies, its reports turned out to be incomplete. One problem the FDA identified in the Manati, Puerto Rico, operation, for instance: "They weren't making sure that facilities used to make sterile drugs were in fact sterile," says Carl I. Turner, the lead FDA attorney on the Schering case.

Schering's run-ins with the FDA began to intensify in mid-1998. That June the agency cautioned Schering's plant managers at the company's facility in Las Piedras, Puerto Rico, about failing to investigate variability in ten-milligram Claritin tablets. It was the first of three warnings that year. The second involved insufficient testing of Claritin D, Nasonex nasal spray, and Proventil inhalers at Schering's Kenilworth and Union, N.J., plants. In the final warning, investigators charged that Schering line workers in Innishannon, Ireland, failed to ensure that Intron A--an injectable treatment for cancers and chronic hepatitis--was sterile.

The following year, the company was warned again, this time for improper testing of Vanceril and Proventil inhalers, made in the Kenilworth plant. In 2000 the FDA scolded Schering once more, for insufficient quality controls on three products made in Manati: Garamycin, an antibiotic for eye infections, and two allergy treatments, Vancenase AQ and Nasonex. Overall, says the FDA's Turner, Schering-Plough's executives "simply didn't do what it takes to make sure they were in compliance. After all the warnings--years and years--Schering-Plough was still not in compliance with FDA manufacturing rules."

Finally, in 2001, Schering CEO Richard Jay Kogan decided on a new tack. "I am taking full responsibility for resolving these matters in a timely manner and securing FDA's confidence," he told shareholders in February 2001. During a year in which the company's sales growth was expected to be flat (and, indeed, it was), Kogan committed to spend more than $50 million to improve manufacturing and quality control. By summer 2001 the company had formed a Worldwide Quality Operations unit, with independent authority to tackle quality issues, including technology upgrades and internal investigations. Schering also hired about 300 quality-control and production personnel, executives, scientists, and consultants. Lastly, Kogan had the company form a review board, made up of three former FDA officials, to oversee Schering's compliance with FDA rules.

But the changes came too late. By last December the company's lawyers were forced to negotiate a consent decree with the FDA and the Justice Department. Eventually Schering agreed to pay a $500 million fine, the largest in FDA history, announced last May. "I believe the fine says a lot about the level of the violation," says Christopher J. Christie, U.S. Attorney for the district of New Jersey. "It's never easy to come up with a monetary figure on these things, but this was a systemic problem that needed to be dealt with severely." Under the settlement, Schering agreed to suspend manufacture of 73 drugs and improve its production processes for another 120 prescription and over-the-counter medicines. The most unfortunate aspect of the settlement: "They were well warned and had the opportunity to avoid all of this," says the FDA's Turner.

Schering, of course, isn't alone in skirmishing with the FDA. The agency--despite its lack of a leader at the helm (see "The Big Gap at the FDA" on fortune.com)--is becoming more rigorous about drug industry oversight. In the past two years Abbott Laboratories, Eli Lilly, Johnson & Johnson, Pfizer, and Pharmacia have all come under fire for production violations. None of those companies, however, rival Schering-Plough in the severity or protracted nature of their violations.

The FDA's regulations are admittedly strict. Under its "current good manufacturing practice" guidelines, every aspect of production--from handling procedures and laboratory conditions to the ingredients in the products--must be tested and retested continually. If, for example, a company changes a single piece of equipment in its production line, plant managers are required to generate several studies of the entire production line to guarantee uniformity of the end product. The rules change from time to time. "If one company comes up with a new way to ensure quality, that quickly becomes the standard for the industry," says William Vodra, a former FDA lawyer who wrote the current regulations in the late 1970s. All these quality controls, of course, are meant to ensure that the drugs that reach consumers' medicine cabinets are safe and effective. And though they have their faults, the regulations aren't difficult for the majority of drug companies to adhere to.

Running afoul of the FDA is clearly bad for business. In addition to the hefty fine, the consent decree carries extra not-so-hidden costs. Schering, for instance, will lose roughly $300 million in sales this year as a result of its agreement not to produce certain products. Furthermore, the company's cost for hiring new employees and upgrading systems to comply with FDA standards is estimated at nearly $100 million this year. More important, the FDA held up its approval of Clarinex, Schering's over-the-counter antihistamine, for more than a year because of the company's failure to comply with manufacturing regulations. "Clarinex was approvable in January 2001. There's no reason to assume that Clarinex wouldn't have delivered over $500 million had it been approved last year," says Mara Goldstein, an analyst with the CIBC World Markets investment firm. "The manufacturing problems affected the entire corporation." Indeed, Schering put a hold on research and development spending to free up money for its compliance efforts. During 2001, Schering's research budget fell by 2%, to $1.31 billion, after increasing 12% in 2000 and 18% in 1999.

Even with the consent decree resolved, Schering's legal troubles are far from over. The company says its manufacturing processes are now the subject of a criminal investigation by the U.S. Attorney's office in New Jersey. The office wouldn't comment on the case.

Shortly after Alexis Milmine began her correspondence with Washington, consumer activist Dr. Sidney Wolfe, director of Public Citizen's Health Research Group, received an anonymous package from a whistleblower at AAC Consulting Group in Rockville, Md., a firm hired by Schering to conduct inspections at its Kenilworth plant in 2000. Part of AAC's mandate was to determine whether managers and operators perceived a real change in the company's commitment to improving production quality in the aftermath of the inhaler recall. The whistleblower's package contained damning audits, which were based on inspections as well as interviews. The most unflattering revelations, according to the documents, came from factory staffers. "They state that for many years they have been under significant pressure to get production out and don't feel they have had enough time or people to do a quality job," AAC concluded. "They indicated that there has been in the past a continual push for increased production and decreased downtime, sometimes at the expense of quality work and [FDA] compliance."

The information from AAC rounded out some of Wolfe's own research on Schering. Over the years he had compiled a list of at least 17 people whose deaths allegedly were caused by faulty Schering inhalers. Wolfe forwarded his data to politicians and agency heads, urging them to launch criminal proceedings. It's unclear what effect Wolfe's actions had, but he says that he has been interviewed several times by the U.S. Attorney's office and is cooperating with the probe. The question that investigators hope to answer: Did Schering-Plough executives ship products that they knew to be defective? "Somebody knew," says Dr. Wolfe. "Here's this auditor saying, 'From top to bottom, you're doing a bad job.' There's no excuse for sloppy manufacturing. It's just bad management."

Schering says it doesn't believe its products caused any fatalities. "Schering-Plough knows of no known case of death or injury to a patient caused by lack of ingredients in one of its inhalers," a company spokesman said.

Schering's operating woes are especially unfortunate, since they've drawn attention away from the company's relatively healthy outlook. At a time when most Big Pharma firms are suffering from a dearth of new drugs, Schering has a set of innovative medicines. Those that have recently entered the market--and those that are forthcoming--such as Clarinex, Zetia (a cholesterol-lowering medicine jointly developed with Merck), Peg Intron (a hepatitis treatment), and Asmanex (another inhaled asthma treatment), have the potential to add "between $4 billion and $5 billion in [annual] sales between 2003 and 2006," notes Morgan Stanley analyst Jami Rubin. Still, those drugs will pass through Schering's production line. If the company can't guarantee that all its products are effective and safe, more customers will go the way of Alexis Milmine, who now uses a product called Combivent--made by Boehringer Ingelheim--during those breathtaking moments before an asthma attack.

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