The high price of drug patents (cont.)

By Bethany McLean, Fortune editor-at-large

Commissioner Jon Leibowitz has been particularly outspoken in his view that if reverse payments continue, "prescription drug costs - already the fastest-growing segment of our nation's spending on health care - will rise even more dramatically."

But the FTC has met formidable opposition from nearly the entire pharmaceutical industry. While the generics and the brands are usually at each other's throat, in this battle they are allies. Leibowitz even joked in a recent speech that "whenever the phone rings in my office, I half expect it to be a call from the Nobel committee telling me that the FTC has been nominated for a Peace Prize."

Nor has the FTC found much support from the courts - or, strangely enough, from the Justice Department. In recent years both the 2nd and the 11th circuits of the U.S. Court of Appeals have delivered major decisions against the FTC. The basic logic: Since a patent is a right to exclude competition, the patent holder has the right to strike a settlement as long as it doesn't extend the monopoly past the patent's term.

The courts have also said that it is hard to distinguish a "reverse payment" from a legitimate business deal. In an incredibly rare dissent with a government agency - lawyers struggle to recall other examples - the Justice Department has sided with the Appeals Court against the FTC.

The FTC is now trying to find a case it could win in another circuit of the Court of Appeals, thereby causing a split in the circuits and encouraging the Supreme Court to take on the issue.

In the meantime Congress has stepped in. On Jan. 17, Senator Herb Kohl (D-Wisconsin) proposed a bill that would make it "unlawful" for a settlement between a drug patent holder and a generic challenger to "include an exchange of anything of value." Expect major pushback from both generic companies and the notoriously powerful Big Pharma lobby.

Finding the loopholes

Besides Congressmen, the FTC has another ally - Bernard Sherman, the Apotex CEO. Here's how he played out his "settlement" with Bristol and Sanofi: First, Sherman asked the patent holders for permission to launch generic Plavix right away should the FTC and state attorneys general turn the settlement down. (The regulators had that power because Bristol was operating under a consent decree stemming from past bad behavior over its patented drugs.) Bristol and Sanofi agreed and said generic Plavix could stay on the market for a window of five days in such an event.

Then Sherman's lawyers told the regulators that Bristol had offered Apotex unwritten side arrangements. The regulators rejected the settlement. They decline to say why, and Sherman says he thinks they would have rejected the deal regardless of the side arrangements.

Apotex immediately flooded the market with generic Plavix it had already made, selling a six-month supply before Bristol could get an injunction to stop it. Instead of the $40 million that it would have collected in the settlement, Sherman's company probably made multiples of that by actually selling the drug. In September, Dolan - long under fire - lost his job, at least partly as a result of this bungled deal.

The Justice Department has launched a criminal antitrust investigation into the settlement. Bristol denies that it ever made any unwritten side agreements. (It also says that the $40 million in the settlement would not have been a payment to keep generic Plavix off the market, but rather one to reimburse Apotex for what it had manufactured.)

Sherman won't actually come out and say that his settlement agreement was a ruse, but he has said that he extracted concessions from Bristol fully expecting that the regulators would scuttle it. He says Apotex has never settled a patent case: "Both generics and brands are trying to make more money at the public expense," he says.

Sherman is trying to blow up another settlement as well - one that the FTC is also eyeing. That's a recent deal struck by a company called Cephalon (Charts) over its narcolepsy drug, Provigil.

Provigil, which was launched by Cephalon in early 1999 and had 2006 sales of roughly $700 million, had a patent that was supposed to last until 2015. But in December 2002 four generic-drug makers filed with the FDA to make generic versions; Cephalon, in turn, filed suits against all four companies. Cephalon's stock price fell about 25 percent; analysts predicted that generics would quickly take 90 percent of the market.

But in late 2005 and early 2006, Cephalon announced settlements with each of the challengers, giving them the right to enter the market in the spring of 2012 - three years before Cephalon's patent was due to expire. Cephalon also struck licensing, co-development and other agreements with the four companies that resulted in total payments to them of $136 million. (John Osborn, Cephalon's general counsel, says that he does not believe these payments qualify as reverse payments.)

The settlements were good news for Cephalon, which saw its stock soar some 50 percent. CEO Frank Baldino bragged to one newspaper that "we were able to get six more years of patent protection. That's $4 billion in sales that no one had expected." And it was good news for the generic makers. Because they had all filed on the same day, they would have had to share the 180-day period - meaning profits would have been slim even during the period of supposed exclusivity.

A handful of lawsuits have been filed against Cephalon and the generic companies, alleging that consumers will have to pay substantially higher prices as a result of the settlements. Among them is a suit by Apotex, which alleges that Cephalon "paid the Generic Defendants to maintain its monopoly on Provigil."

Sherman argues that if a generic company settles, it should forfeit its 180 days of exclusivity. "Generics are selling the right to keep others off the market," he says. "What was supposed to be an incentive has been bastardized and subverted."

Sherman says his only goal is "to serve consumers." But while his peers may be gaming the system, he may not be above playing games of his own.

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