Know your risksEmerging markets, third-party intermediaries, and the life sciences industry

Contents

Know the TPIs in your emerging market 4

Know your options: Making the right choices 7

Know your risks, and reap the rewards 9

Contacts 10

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If life sciences companies are to thrive in today’s challenging global environment, they must overcome more than shrinking pipelines, patent expirations, and competition from generic manufacturers. They also face regulatory scrutiny from government agencies in the United States and across the globe. And they may need to collaborate with and rely on third-party business partners to increase, or at least maintain, existing market share in emerging markets—which can be increasingly critical to market growth strategies.

But life sciences companies should proceed with caution. While emerging markets may represent incredible growth opportunities, they are still developing, and many have reputations for seemingly pervasive corruption in their business practices and processes. Regulatory challenges, fines, and penalties may be triggered by a combination of decisions made and tactics employed by local business operations and their use of regional third-party intermediaries (TPIs) to distribute medicines, diagnostic tools, medical devices, and products into the hands of healthcare professionals, patients, hospitals, and consumers.

From January 2009 through September 2010, fines for healthcare companies ranged from $22 million to over $2 billion. Consider the following examples: A pharmaceutical company was fined close to $10 million after being charged with making improper payments to agents of a former Middle Eastern government. These payments were made in order to obtain contracts with that government’s ministry of health. An international medical device maker and its subsidiary pleaded guilty to shipping adulterated and misbranded commerce, resulting in more than $20 million in criminal monetary penalties. Employees in this case also faced criminal charges.

The potential exposure to such adverse consequences could be particularly significant in emerging markets that may represent major future growth opportunities for pharmaceutical, medical device, and biotechnology companies. The triggers leading to fines, penalties, and sanctions (such as deferred prosecution agreements and corporate integrity agreements), along with the potential impact on reputation and financial statements, might be attributed to the fact that emerging market economies often lack a reliable business and technology infrastructure, transparent business practices regarding employee incentives and interaction with TPIs, strong and effective accountability and controls, and well-established distribution channels. What’s more, local traditional business practices, governed by the culture of the emerging market region, are frequently at odds with global corporate policies and international government regulators.

In addition to regulatory exposure, activities between life science companies and TPIs in emerging markets may lead to other undesirable consequences, such as reputation risk, revenue leakage, cost overruns, financial fraud, diverted

Defining our termsFor the purposes of this paper, we define life sciences companies and emerging markets as follows:

Life sciences firms• are pharmaceutical, biotechnology, and medical device and diagnostic companies.

Emerging markets • are those nations with social or business activity marked by rapid growth and industrialization.

Know your risks Emerging markets, third-party intermediaries, and the life sciences industry 1

products, and more—which could have a negative impact on a company’s shareholder value. Companies may attempt to design and implement controls to mitigate the risk of such incidents. However, the risks and consequential outcomes from these events are often not easily quantified, as they are frequently “masked” through activities buried in business transactions, fuzzy language contained in the contracts, and handshake deals with TPIs.

Furthermore, it is not an uncommon occurrence in many emerging markets for a local sales representative or senior-level director to circumvent controls or manipulate certain terms in contracts with TPIs in order to obtain free

products or to increase commissions, allowances, and incentives. Similarly, these individuals may, as part of a scheme to accumulate cash funds, steal from the company or assist TPIs in making bribe payments to procurement officers and other managers who are responsible for purchasing pharmaceuticals and medical devices.

This paper identifies these and other specific threats that should be considered by life sciences companies. It also discusses practical steps for evaluating and managing the risks of doing business with TPIs in mission-critical global markets.

Figure 1: Know your global compliance concerns

© 2011. Deloitte Development LLC. All rights reserved.

Life sciences companies face compliance concerns that can be very real, and the consequences of non-compliance can be high. In today’s marketplace, companies are subject to enforcement by various authorities across the globe.

Federal service onsurveillance of healthcareand social development of Russian Federation(Roszdravnadzor).

Pharmaceutical and Food Safety Bureau (PFSB)

ADB-OECD Action Plan for Asia-Pacific (Action Plan)

Liberia Anti-Counterfeit Drugs Agency

Inter-American Convention against Corruption (OAS Convention)

FDA, OIG, SEC FTC, and Congress

European Medicines Agency (EMEA)

Medicines and Healthcare products Regulatory Agency (MHRA)

Special Investigation Unit (SIU) Federal Agency for Medicines and Health

African Union Convention on Preventing and Combating Corruption (AU Convention)

Southern African Development Community Protocol against Corruption (SADC Protocol)

Economic Community Of West African States Protocol on the Fight against Corruption (ECOWAS Protocol)

European Anti-FraudOffice (OLAF)

Serious Fraud InvestigationOffice (SFIO)

General Prosecutor’s Office,Anti-Corruption Agency

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Know your third-party intermediaries TPIs play an important role in distribution channels by bridging cultural divides and providing access to existing customer networks and relationships with state-owned entities, such as hospitals, pharmacies, and similar types of healthcare institutions. The relationship between third parties and their existing networks and customers are subject to significant business and regulatory constraints. Based on the broad reach of certain anti-corruption and related laws, rules, and regulations, the company contracting with a TPI may be held accountable for the activities of that third-party intermediary, as well as the TPI’s subcontractors that are involved in any questionable transaction.

The definition of a TPI differs from country to country. While by no means a comprehensive list, a few examples of TPIs that do business with life sciences companies are listed below:

Sales agents, distributors, resellers, and manufacturers•

Marketing and conference organizers•

Contract research organizers•

Healthcare professionals, including physicians and hospitals•

Joint venture, co-promotion, and strategic alliance partners•

Travel agents, shipping agents, and other transportation vendors•

Consultants and other contractors or vendors that interact with healthcare professionals •

Know your risks Emerging markets, third-party intermediaries, and the life sciences industry 3

Know the TPIs in your emerging market

The successful establishment or enhancement of a presence in emerging markets requires a deep understanding of the business practices and regulatory requirements that are particular to those specific countries. Boosting sales efforts in emerging market countries may lead to exposures that are exacerbated by a lack of visibility, understanding, and accountability regarding TPIs’ arrangements, particularly with respect to:

Business and cultural practices that shape relationships •between TPIs and healthcare professionals, foreign officials, and other third parties in a position to influence purchasing decisions on the volume or value of sales of the life sciences company’s products

Precise scope of goods, services, payments, and other •financial arrangements with TPIs, which result from the frequent lack of developed processes relating to fee for service, compensation, contracting, financial reporting, communication, data analytic tools, monitoring, and auditing

Systems, internal controls, and processes used by TPIs in •business practices

Requirements necessary to comply with the laws, rules, •and regulations that govern the activities of TPIs in the particular country

Increased exposure to fines, penalties, and sanctions can be a direct result of heightened enforcement efforts of both U.S. and foreign regulatory agencies that exercise jurisdiction over activities conducted by U.S. companies abroad. Foreign Corrupt Practices Act (FCPA) enforcement activity is expected to further accelerate during upcoming years. New foreign and international anti-corruption requirements are also expected to boost enforcement activity—including the U.K. Bribery Act, which outlaws both commercial and government bribery, as well as conventions adopted by the United Nations, the European Commission, and the Organization for Economic Cooperation and Development. These recent enforcement developments are designed to further facilitate information sharing and cross-border cooperation as well.

Some potential dangers that should be addressed when considering an arrangement with a TPI include:

Payments to “foreign officials.” • In many emerging market countries, hospitals, pharmacies, research and

development facilities, and other types of healthcare institutions are owned or operated by the government (directly and indirectly). Payments by TPIs to physicians or employees who work in state-owned entities or are employed by the government may be deemed by regulators to be payments to a “foreign official”—subject to the reach of the FCPA. The FCPA expressly prohibits companies from compensating foreign officials for the purpose of obtaining or keeping business, even when those payments are made via TPIs. Other countries may also have similar anti-corruption laws, which life sciences companies must understand and navigate as well.

Local regulatory standards. • Arrangements by and among life sciences companies, TPIs, and various customers and end users may also be subject to extensive regulation under country-specific standards relating to fraud, abuse, quality, and other issues. Such country-specific regulations should be carefully evaluated in conjunction with the assessment of the company’s global compliance requirements. Foreign subsidiary management may often be inadequately trained and supervised by the corporate office to follow various international and local laws and corporate policies.

Contract deficiencies and lack of visibility. • The contracting standards for TPI arrangements in the local country may depart significantly from standards that are frequently employed in more developed markets. In addition, contracting arrangements with TPIs, if they exist, often lack customary terms and conditions that are necessary to safeguard the interests of the company and carefully measure performance of the TPI relative to the contract. It is important that contracts have safeguards in place and are negotiated to provide guidance and definitions of price points, discounts, allowances, rebates, commissions, free product, and so forth with distributors, manufacturers, and other TPIs. Furthermore, fees paid to healthcare professionals, physicians, and other vendors such as travel agents, conference organizers, and sales agents should be negotiated at “arms length” and at fair market value. Deviations from established pricing guidelines should be evaluated before approved by senior-level members of management. Rights to audit, as well as anti-corruption provisions, should also be in TPI agreements.

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Local business practices and culture. • In many emerging markets, certain financial arrangements and other business practices with TPIs might not be compatible with a U.S.-based organization’s ethics and values. For example, illegal pricing schemes and information leaks to competitors that are inconsistent with legal or ethical standards followed by U.S. companies may actually be regarded as customary business practices in some emerging markets,

particularly given the immense competition for talent, intellectual property, and market share in certain regions. Another problem may be denial. When locally based employees and managers face a conflict of interest—pitting personal performance goals and rewards against reporting poor results and bad news to corporate—culture (compounded by self-interest) may lead people to bury the facts.

Figure 2: Know your emerging markets—and their perceived corruption levels

Source: www.transparency.org

The 2010 corruption perceptions index measures the perceived levels of public-sector corruption in 178 countries arround the world

2010 CPI Score

9.0 - 10.0Veryclean

Highlycorrupt

8.0 - 8.97.0 - 7.96.0 - 6.95.0 - 5.94.0 - 4.93.0 - 3.92.0 - 2.91.0 - 1.90.0 - 0.9No data

While emerging markets may be critical to future growth opportunities for pharmaceutical, medical device, and biotechnology companies, many of these emerging-market countries are also marked by significant levels of corruption, as measured by Transparency International’s corruption level-of-risk rankings.

Know your risks Emerging markets, third-party intermediaries, and the life sciences industry 5

Know your “red flags”Given human nature and the level of creativity that can be tapped when individuals are motivated by sales goals, business metrics, local business culture, and other types of incentives, life sciences companies should implement processes to evaluate the TPI’s reputation and qualifications. The United States Department of Justice (DOJ) identified certain “red flags” that are warning signals of potential FCPA violations which may arise under third-party relationships.1 These red flags are intended to help companies identify risk areas before the problems grow to an unmanageable level. Warning signs that companies should watch for may include, but are not limited to, the following:

Payments inconsistent with contracts terms•

Handshake deals with TPIs•

Off the record discussions•

Introduction by TPIs of additional third parties into transactions•

“Upfront” payments and deposits requested by the vendor to secure business•

TPI relationships with government officials or employees of state-owned entities•

Request for “unreasonable” compensation for services promised or rendered•

Unusually high commissions, free product, and discounts granted to distributors•

Use of local travel agents that are not approved corporate global vendors•

Requests for reimbursement of expenses lacking documentation•

Incomplete or inaccurate information in required disclosures•

Refusals by TPIs to certify compliance with FCPA/HCC or local laws•

Product not appearing in original packaging or labeling•

Response to change. • Even as structures and processes within the organization are further developed to respond to increasingly stringent regulatory requirements, individuals working with or through TPIs may be tempted to circumvent these newer requirements. The days of stealing from petty cash have evolved to sophisticated schemes that are disguised through ambiguous contract terms between the life sciences company and the TPI. Increased global data analytic

techniques, trending assessments, and focused auditing and monitoring are important efforts in identifying suspicious patterns that may require further follow-up and investigation in the local market. Such activities most likely will not eliminate this growing risk, but they could lead to early warning signs before these problems grow into major issues that can have significant financial and regulatory impact.

1 For more information, see the U.S. Department of Justice’s “Layperson’s Guide to the Foreign Corrupt Practices Act.”

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Know your options: Making the right choices

Working with TPIs in emerging markets and verifying compliance with applicable laws, rules, and regulations requires that a company align its approach to TPI arrangements with its risk objectives, including those relating to risk management, integrity, ethical, and compliance values. A company’s approach to TPIs, based on its risk assessment process, may include the adoption of one or more of the following approaches:

Risk avoidance.• If the risk is deemed to be too great, given the company’s resources or desire to establish a presence in that country, the company may elect to walk away from doing business in that emerging market.

Risk acceptance.• If a company decides to rely solely on TPIs to comply with applicable laws, rules, and regulations, it is accepting responsibility of potential risk and increasing exposure related to that TPI, as well as to any subcontractors that the TPI engages.

Risk reduction. • If a company chooses to reduce its risk by directly taking on the activities performed by TPIs, resource constraints and lack of core competencies might limit its ability to successfully access opportunities in the applicable country.

Risk sharing. • If a company elects to use TPIs to access potential sales opportunities and take steps to reduce the risks, it leverages the knowledge and resources of TPIs. It also makes the most of sales opportunities in a country while still adhering to risk management and other objectives.

The options above would require the company to conduct a risk assessment of specific TPI relationships and determine which risk approach it may implement. Below are some practical steps life sciences companies can take to reduce, share, or transfer risk:

Apply local and global standards consistently to •TPI arrangements. Understand the application of local laws, business practices, culture, and regulatory standards. Consider integrating local standards with global regulatory requirements, as well as developing the company’s global approach to compliance in coordination with legal counsel and others who have business and regulatory experience within the specific country.

Perform due diligence. • Companies should consider verifying the qualifications, reputation, ethical conduct, financial, and other resources of healthcare professionals, foreign officials, and other TPIs. They should also take time to determine if physicians, hospital employees, and others have ties to state-owned institutions. And they should look into whether third-party vendors have a family connection with locally based employee(s) of the life sciences company.

Document business need and purpose. • Life sciences companies should specify the legitimate business purpose or need for creating a relationship with the TPI. They should inquire whether a competitive pricing process was followed before a decision was made to engage the TPI for services. Performing a trending analysis on how contracts were granted with TPIs may also establish a pattern on how decisions are made by local management.

Structure applicable contract language.• Companies should explicitly state the obligations and responsibilities of the TPI. The contractual terms should be established in coordination with legal counsel and others with expertise in local laws and practices and should include, among other items: the specific nature of services to be provided by the TPI; the scope of permissible relationships between the TPI with healthcare professionals, foreign officials, and others in a position to influence the volume or value of services; and the scope of permissible financial arrangements with the TPI (e.g., definitions and limits on discounts, rebates, commission, incentives, and other services applicable to the TPI arrangement). Companies should also consider including the right to audit complete books and records of TPIs in their contracts.

Establish fair market value.• The compensation payable to the TPI should be established and documented at rates and fees that are consistent with fair market value for bona fide services necessary to meet the legitimate business needs of the company. This includes royalties and other fees paid by or through the TPI to physicians, healthcare professionals, and similar types of service providers, as well as commissions, free product, rebates, or discounts to distributors. Local management and policy need to mandate that fair market value assessment is conducted and followed before agreeing to written terms and conditions. Deviations from pricing guidelines should require approval from senior management.

Know your risks Emerging markets, third-party intermediaries, and the life sciences industry 7

Customize practical policies, processes, and internal •controls. Policies developed at a company-wide level frequently do not “take” in certain countries, due to insufficient understanding, competing priorities, or buy-in. Therefore, policies, processes, and internal controls should be flexible to accommodate both local requirements and the established company culture, business model, and code of conduct. The implementation of these policies should also be accompanied by change management strategies that may enhance the “buy-in” of the local countries. Such change management strategies should include strategies for communication, participation by corporate and local personnel, training, and monitoring protocols.

Implement an effective training and anti-corruption •program. As with policy development, training initiatives should be modified to suit the needs of the local market, delivered in the local language, and backed by the support of local management. Training should be provided on an ongoing basis to sales professionals, managers, finance and accounting professionals, and TPIs. Employee goals and incentives should be aligned with expectations from corporate headquarters and local management.

Introduce applicable payment and performance •processes. Payment and performance processes should include the internal controls necessary to establish and document the propriety of the payment to and performance by the TPI, as well as compensation for

local management based on achieving specific sales and market share goals through the use of TPIs. Such processes may include: documentation regarding proof of performance, performance measurement, review of the third party’s compliance practices, and maintenance of adequate books and records.

Conduct ongoing risk monitoring and auditing. •The DOJ recognizes that implementing a compliance program in accordance with the standards established under the Federal Sentencing Guidelines is critical for preventing and detecting improper payments by TPIs. Furthermore, the DOJ also recognizes that active monitoring and auditing plans that assess significant compliance risks are an essential element of an effective compliance program. The effectiveness of an active auditing process is dependent on contract language with the TPI that has clear definitions and guiding principles of what the TPI is responsible for, as well as limits on fees paid and prices charged by the company.

Be prepared for contingencies.• Companies should maintain response protocols to address potential compliance issues that may be identified during the course of a TPI arrangement. To address allegations of non-compliance, corruption, or other misappropriation of assets or lack of good faith by TPIs (or employees interacting with TPIs), the company’s compliance program should have a response protocol that promptly investigates matters and takes remedial steps to mitigate future risk.

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Know your risks, and reap the rewards

Emerging markets provide attractive growth opportunities for life sciences companies. In the majority of these markets, partnering with TPIs is essential to success. But prospects for growth should not blind a company to the corrupt practices or processes that are often employed by TPIs, in keeping with the accepted ways of working within the local business tradition and network.

Therefore, it is important that a life sciences company, its extended organization, and third-party business partners comply with local and international laws and regulations. Understanding the regulatory and business risks of doing business in the local market is essential. Knowing the warning signs—and implementing applicable processes, effective monitoring and auditing, controls, and systems to address such risks—may help life sciences companies better manage TPI relationships, increase shareholder value, reduce the scrutiny of regulators, and potentially avoid adverse consequences.

Know your risks Emerging markets, third-party intermediaries, and the life sciences industry 9

This publication contains general information only and Deloitte is not, by means of this publication, rendering accounting, business, financial, investment, legal, tax, or other professional advice or services. This publication is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified professional advisor.

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