Corruption Risk in the Chinese Pharmaceutical Market

Deloitte Forensic China

The issue In 2009, China unveiled a major health care reform initiative which has the objective of providing improved health services to China’s billion-plus population. A stillincreasing population and income growth means that health care spending in China will grow dramatically by 2020, according to some estimates. The potential political fallout if the initiative is seen to be ineffective, and the significant sums of money involved, means that addressing graft in the health care industry is a key component of China’s nationwide anti-corruption drive. The serious intent of the anti-corruption drive was underscored by a recent fact-finding enquiry of a multinational pharmaceutical company. This action against alleged bribe payers, as opposed to the traditional focus on bribe recipients, is the first of its kind against multinational pharmaceutical companies operating in China. Chinese authorities are expected to continue tackling issues within the industry with the National Development and Reform Commission looking into potential overpricing by 60 pharmaceutical companies and China’s Food and Drug Administration launching a six-month campaign to clean up China’s health care system, primarily to tighten industry regulations and rein in illegal online drug sales. Cause for concern The pharmaceutical industry is a sensitive area because it affects the general public. Corruption allegations may have a severe negative impact on a company’s brand and reputation along with significant costs, not the least of which are loss of market share, fines, and penalties that could approach hundreds of millions of dollars. In addition, one enquiry can have a domino effect; we are increasingly seeing cross‑jurisdiction communication between the various regulators and prosecutors. This may result in further regulatory scrutiny by regulators and prosecutors in particular in relation to the Foreign Corrupt Practices Act (FCPA) and the UK Bribery Act. The Chinese government-dominated health care system presents a set of unique risks and challenges to large multinational pharmaceutical companies. Based on our experience, handling numerous fact-finding enquiries in the industry, we have identified several key risk areas in China including: 1. Inappropriate payments to key opinion leaders during bidding or government approval bodies during clinical trials and product licensing 2

2. Inappropriate benefits and payments made to health care practitioners by distributors through profit margins and sponsorships 3. Excessive gifts to health care practitioners 4. Fictitious marketing/education events to create slush funds supported by fabricated documents (fake receipts, attendance sheets, pictures, etc.) 5. Fictitious expense claims to support the creation of slush funds for inappropriate payments 6. Collusion with travel agents, vendors, or agents regarding fictitious sponsorships, speaker fees, and inappropriate side trips, per diem provided to doctors during overseas conferences 7. Free goods and samples provided to hospitals by distributors who sell the products in the black market and generate funds to provide inappropriate benefits to doctors and hospitals 8. Related books and records accounting issues What to do now Pharmaceutical companies operating in China should be ‘prepared’ for increased scrutiny. While a corporation may have an anti-corruption policy in place, it should perform a corruption risk assessment across its operations in China. Areas to consider as part of the risk assessment include: • Sufficiency of compliance programs in place including, but not limited to, policies, procedures, and training. • The use of and the role of third parties, whether there are agreements in place with those third parties and whether those agreements contain anti-bribery clauses – in addition, the key terms of those agreements should be reviewed in particular in relation to payment methods. • The level of due diligence performed on third parties used. • Potential red flags previously identified by Internal Audit or Internal Compliance function. • Previous reports of an anti-bribery and corruption nature made through the company’s internal reporting channels, for example, a whistle-blowing hotline. • High-risk areas such as research and development activities, drug trials, launch of new drugs, medical conferences, entertainment, marketing, and donations.

• Payments made to third parties. • Sales methods used in China. • Distribution networks. • Interaction with state-owned businesses and government officials. • Existence of any business partnerships or joint ventures. • Existence or availability of incentives or reimbursements for customers or third-party distributors paid in a variety of ways including through the use of rebates, special discounts, or credit notes. • Payments to state officials who are in a position to influence products that are approved by the State Food and Drug Administration and the Bureau of Drug Policy Administration, agencies similar to the Food and Drug Administration in the United States. • China maintains both a national and provincial set of pharmaceutical reimbursement schedules in state-run hospitals or clinics – and because of the different systems of the national, provincial and municipal governments, the risk of issues, such as influence pricing, is more diverse.

Once an assessment has been completed, companies should prepare for a potential enquiry by taking some proactive measures to assess the current state of their operations in order to respond quickly and credibly to initial enquiries. Steps to take now to prepare are: • Review your compliance programs and their coverage over corruption issues. • Review all third-party interactions. • Review of potential red flags/previous incidents highlighted through internal compliance procedures (e.g., whistle-blower allegations, complaints received, etc.). • Monitor the entities of concern in the media and assess your interaction with them. • Conduct appropriate due diligence on third parties commensurate with risk. Taking steps now can significantly reduce the impact of the results of an enquiry on reputation and operations and also help mitigate any fines or penalties.

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The Deloitte advantage Deloitte Forensic is one of the largest dedicated forensic practices in the world, with more than 2,300 forensic professionals around the globe. Our Asia Pacific forensic practice has more than 40 partners and 450 practitioners. This year, Deloitte Forensic was ranked No. 1 in Kennedy’s Forensics and Dispute Advisory Services Report 2013 based on the depth and breadth of services we provide our clients. Deloitte has developed proprietary forensic analytics and visualization tools for analyzing large amounts of data to identify potential red flags. The Deloitte Analytics Platform and FCPA Analytics leverage years of enquiries, health check, and diligence experience with fraud and corruption matters to provide clients with a hosted solution for performing sophisticated data examinations. Deloitte’s Enterprise Fraud and Misuse Management provide an advanced technology framework to help an organization seek out and proactively guard against threats.

Deloitte can apply its analytics acumen to a variety of pharmaceutical-related matters such as analyzing prescription patterns to identify inappropriate off-label prescriptions or excessive brand name over generic prescriptions; and health care knowledge to identify the clinical scenarios where this would constitute inappropriate practice. Our China Life Sciences & Health Care (LSHC) practice includes 21 offices nationwide with a dedicated team composed of approximately 80 partners and 560 practitioners. We serve multinational players including 10 of the largest pharmaceutical manufacturers, 9 of the 10 largest medical equipment manufacturers, 6 of the 10 largest Chinese pharmaceutical distributors, 8 of the 16 pharmaceutical companies in the list of Fortune’s top 500 Chinese companies 2012, and one of the largest Chinese medical devices manufacturers. Deloitte Forensic has handled some of the most complex and large forensic engagements in the world.

Large engineering company fact-finding and controls assessment and remediation Deloitte & Touche GmbH was engaged to assist external counsel in conducting an independent and comprehensive fact-finding enquiry into possible FCPA and anti-corruption violations at a Fortune 50 multinational engineering company operating in a variety of industries including health care. Deloitte was also retained to conduct a comprehensive assessment of the company’s internal control systems and anti-corruption compliance program, identifying gaps against leading practices and making numerous recommendations for improvement. The scale and scope of the project required us to quickly mobilize our forensic professionals around the world with the assistance of 35 Deloitte member firms. Deloitte, with counsel, provided frequent and extensive reports to the Department of Justice (DOJ) and Securities and Exchange Commission (SEC) regarding the progress of the enquiry, which included detailed and significant information on individuals and third-party entities that were used as conduits to conceal corrupt payments made to government officials. These U.S. authorities cited counsel and Deloitte’s work as critical in bringing an unprecedented fact finding to conclusion in a relatively short period of time. 4

A sample of anti-bribery and corruption-related engagements conducted by Deloitte in the pharmaceutical industry Deloitte has assisted in more than 30 enquiries during the past two years for a multinational pharmaceutical company in China into reported allegations of disguised payments to hospital staff directly, as well as indirectly through distributors, in attempts to promote businesses in the medical sector. These enquiries have typically involved an analysis of data supporting expense claims and marketing activities, background checks on third-party travel agents, imaging and searching computers, and interviews. These enquiries uncovered fake receipts, unsupported expenses claims, excessive charges and cash refunds by vendors, significant speaker fees at events, and fabricated documentation for events that did not in fact occur. Deloitte performed a fact-finding exercise on behalf of the board of a Swiss pharmaceutical distributor into allegations of corruption with respect to operations in East European markets. The engagement required detailed transactional testing and analysis as well as interviews being conducted with relevant individuals. The findings of the exercise formed the basis of a report to the company’s board. Deloitte performed a fact-finding exercise on behalf of a major pharmaceutical company into allegations of improper payments being made to health care professionals (HCPs). The work included detailed analysis of computer records and hard copy documentation. Our findings were used as the basis of presentations to the DOJ and SEC. Deloitte Financial Advisory Services LLP assisted external counsel with an internal assessment on behalf of a medical equipment manufacturer in response to whistle-blower complaints and other compliance concerns related to the company’s sales and operations in Latin America (including Argentina, Brazil, Colombia, Mexico, and Chile). The work involved detailed transactional testing, interviews, tender/sales analysis, background checks, e-discovery/ computer forensics, as well as document review. As part of the assessment, we performed extensive analysis of the company’s distributor/ network in South America, including analysis of third parties and the identification of “red flag” transactions. Additionally, we assisted counsel with reporting to the company’s executive management team and board presentations.

Deloitte assisted a U.S.-listed manufacturer of health care, pharmaceutical, and medical products to conduct several enquiries in various locations in Asia. Our team conducted enquiries into alleged conflict of interests, misappropriation of company’s assets, misconduct of senior management, and potential inappropriate payments to government officials in various Chinese cities and in Korea. Deloitte also worked with the Internal Audit team to review expenses claims and marketing expenses over several years and conducted confrontational interviews in China, which revealed a systematic commission mechanism to individuals.

Deloitte worked with counsel representing a major pharmaceutical company before the DOJ and SEC with respect to potential violations of the FCPA. The work involved detailed transactional testing and a review of policies and procedures in a number of countries including Russia and in Central and Eastern Europe and the Middle East. Our findings were used as the basis of presentations made to the relevant authorities.

Deloitte was engaged to conduct an anti-bribery and corruption review at our client’s operations in South America, Africa, and the Middle East. The work included a review of anti-bribery and corruption compliance in relation to sales and distribution practices. Our review focused on relationships with third parties and distributors, the use of cash, and relationships with HCPs. With respect to distributors, we reviewed the implementation of the relevant agreements. In addition, we reviewed sales, payments, and credit notes related to the distributors. We held meetings and analyzed accounting records and supporting documentation to determine the nature of the relationship with other third parties. This matter is still ongoing. Deloitte performed a fact-finding exercise on behalf of a U.S. medical device manufacturer into allegations of evasion of customs duties within its Russian operations. The factfinding exercise involved transactional testing and interviews of interested parties and resulted in a report being made to the company’s audit committee. Deloitte performed an integrity and FCPA compliance assessment for a medical services company. Services performed included conducting an integrity and FCPA compliance assessment on a potential acquisition target in China on behalf of a U.S.-listed company. In addition, Deloitte conducted detail analyses of traveling and entertainment expenses; payments to agents, contractors, and suppliers; assessment of the overall compliance environment; and integrity due diligence to ascertain the identity of the owners, the target’s operation, and its reputation within the industry. As a result, Deloitte identified suspicious consulting arrangements to facilitate the approval of new drugs, as well as cash rebates to doctors and drug store staff supported by fictitious expense claims. Deloitte was engaged to perform an assessment of domestic and international regulatory functions and recommend a compliance organizational structure and standards framework, including a rewrite of existing U.S. Standard Operating Procedures (SOPs) and drafting of new SOPs that were lacking, and the design of the global regulatory function training program to assist in implementing the SOPs. Deloitte assessed existing compliance organizational structure and processes to identify compliance gaps and key areas for operational improvements, read regulatory compliance policies and standards to identify compliance gaps and remedial actions, understood the information technology landscape to identify potential opportunities for technology efficiencies, helped to design a new global regulatory operating model including realignment of regulatory roles and detailed job descriptions, recommended updated standards and procedures to support a new global regulatory compliance framework, and assisted with the creation of an overarching outsourcing strategy to help guide many outsourcing decisions. Corruption Risk in the Chinese Pharmaceutical Market

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Our team China Forensic

China LSHC Nick Robinson Partner, Deloitte Forensic
 Deloitte & Touche Financial Advisory Services Limited Tel: +852 2238 7085 Email: [email protected] Location: Hong Kong

Yvonne Wu Life Sciences & Health Care Managing Partner Deloitte Touche Tohmatsu Certified Public Accountants LLP Tel: +86 21 61411570 Email: [email protected] Location: Shanghai

Global LSHC Pete Mooney DC Principal, Global SRM
 Deloitte Touche Tohmatsu Limited Tel: +1 617 437 2933 Email: [email protected] Location: Boston Global Forensic UK/Europe

USA Peter Maher Partner, Deloitte Forensic Deloitte LLP Tel: +44 20 7303 3180 Email: [email protected] Location: London

Chris Georgiou Partner, Deloitte Forensic Deloitte Financial Advisory Services LLP Tel: +1 212 436 3331 Email: [email protected] Location: New York

Canada (and Americas) ­ Peter Dent Partner, Deloitte Forensic Deloitte Financial Advisory Services LLP Tel: +1 416 601 6692 Email: [email protected] Location: Toronto

Ed Rial Principal, Deloitte Forensic Deloitte Financial Advisory Services LLP Tel: +1 212 436 5809 Email: [email protected] Location: New York

Belinda Tan Executive Director, Deloitte Forensic
 Deloitte & Touche Financial Advisory Services Pte Ltd. Tel: +65 6530 8039 Email: [email protected] Location: Singapore

Jeremy Perisho Partner, Deloitte Forensic Deloitte Financial Advisory Services LLP Tel: +1 617 437 2975 Email: [email protected] Location: Boston

South East Asia

Australia Chris Noble Partner, Deloitte Forensic
 Deloitte Touche Tohmatsu Tel: +617 3308 7065 Email: [email protected] Location: Brisbane 6

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