ASIA BEAT: GSK, bribery and the China conundrum

Let's step back for a minute from the global media brouhaha over the Chinese bribery probe of GlaxoSmithKline and look at some of the hard facts so far.

Four senior executives from the firm's Chinese operations have been detained on suspicion of corruption, none yet formally arrested or convicted of wrongdoing.

A number of other pharma multinationals are rumored to be under investigation by the ministry of public security (MoPS) but no other probes have been officially confirmed; no further people have been detained; and several firms reportedly under official suspicion have told Scrip they haven't even been contacted by authorities.

A crackdown on corruption across all sectors has been a stated priority at least of the central government for years and is a well-publicized policy focus of new President Xi Jinping.

So why all the fuss and surprise?

Several reasons. First, the amount of money the ministry claims is involved in the GSK case – about $489 million in dubious funds processed over a six-year period through intermediaries including travel agencies – is substantial.

Secondly, faced with a public statement from the MoPS (presumably backed up by hard evidence), the firm has been quick to admit it was "ashamed" at the allegations, and after previously maintaining no evidence of wrongdoing has conceded some of its local executives were at fault.

The third big issue is that an investigation of a leading pharma multinational – regardless of any proven illegal activity – is being seen as evidence that China is unfairly targeting such firms to build up its own industry, when it should be trying instead to keep its own house in order.

Within these areas, there have also been some unusual facets. The firm's UK-based senior executive with responsibility for China, Abbas Hussain, effectively admitted the detained executives' guilt this week after saying they acted outside internal safeguards in a way that "breaches Chinese law."

Given that one of those being investigated had already appeared on Chinese state television confessing to funneling irregular payments through a travel agency, perhaps he had little choice.

But GSK's response also suggested a conscious eye on the need to show respect for authority and the conciliatory power of a formal admission of shame – something CEO Andrew Witty should be aware of from his time in Asia – which it may be hoping will minimize the reputational and eventual financial damage.

The apology also seemed to be an attempt to isolate a few "bad apples" acting individually and irresponsibly against strict internal standards without the knowledge of HQ.

The evidence that GSK is being held up as some sort of sacrificial lamb in a larger coordinated witch hunt of foreign and/or pharma firms is mixed. Those who have followed the Chinese pharma sector for any period know there have in fact been numerous official investigations and arrests at domestic firms that often go unreported outside the country, although these are usually related to unlicensed facilities and product quality scandals.

And anyone who thinks that China's official hard line against corruption is something new has probably forgotten that the former director of the then China State FDA, Zheng Xiaoyu, was put to death in 2007 for receiving over $1 million in bribes related to drug approvals.

More recent indications of a toughening stance have been apparent, included the adoption by the China FDA last year of "naming and shaming" tactics and a blacklist for individuals involved in illegal activity (Asia Beat, 3 October 2012).

As the Chinese media would have it, the GSK case serves simply to illustrate Beijing's resolve to improve the business climate and as a warning to other Chinese and foreign pharma companies to abide by the law, the message being that wrongdoing will be pursued regardless of suspects' origins.

flip side

On the more cynical flip side of the coin though, there are signs the GSK probe may also have been designed to give the impression the central government is taking serious steps to tackle corruption.

The investigation has been widely reported in the (state-controlled) media, backed by unusual public statements from the MoPS itself, and – given the company involved – it must have been known that broad international exposure would quickly follow.

In another sweeping move, the Chinese government has for instance just slapped a five-year ban on all new construction work for government buildings to curb unnecessary spending and corrupt links between officials and building firms. (As an aside here, pictures surfaced on the internet several years ago of an opulent, Palace of Versailles-like facility built by the state-owned drugs firm Harbin Pharmaceuticals.)

Chinese media time given to airing past transgressions by foreign pharma firms also suggests a little bit of demonizing may be going on. Covered have been GSK's $3 billion settlement last year of US civil and criminal charges stemming from activities including payments to doctors, and Lilly and Pfizer's payments (around $29 million and $60 million respectively) to the US SEC over claims of violations of the US Foreign Corrupt Practices Act in markets that included China.

In echoes of the current GSK case, Lilly was alleged to have made false expense claims and hidden improper gifts and cash payments to government-employed physicians in China.

Notable is the absence in all this of rumors that the largest players in China's pharma industry – the huge state-owned conglomerates involved in everything from manufacturing to retail – are being investigated, although there have been some reports of small scale local corruption at some firms.

So was GSK intentionally chosen as a high-profile target when similar activities might well be unearthed at other domestic or foreign pharma companies put to scrutiny? We will never know, but how far the official probe widens, and whether it turns out to be just the first shot in a wider assault on the whole sector, will be an indication of that.

Other political factors can't be discounted either, notably rising healthcare costs as China expands its insurance coverage and increases reimbursement of essential drugs, creating new spending that is in turn becoming pressured by the slowing economy.

The claim by one of the detained GSK China executives that operating costs, including bribery, account for 20-30% of product end prices only adds weight to official efforts to further clamp down on drug prices.

Consciously or not, Mr Hussain's pledge to the MoPS to pass on "operational cost savings" in the form of drug price reductions played to a sensitive issue with the public and would mark a face-saving political win for the government from the GSK probe. The message would be: "We took tough action and got a result valuable to the public."

Nevertheless, it remains hard to believe that Beijing will go all out to attack foreign pharma firms given their substantial investments in China, important role in the healthcare system, and the risk to further foreign investment in a cooling economy.

wider lessons

Whatever the broader context, the affair points to something gone badly wrong in some individuals' practices in GSK China. The real surprise should not be that bribery and corruption are going on in the country, where such practices go back centuries and are an ingrained part of the business and political landscape, but rather that strict, modern oversight systems and legal requirements can apparently fail.

What really stands out as the yet unresolved mystery is how local execs managed to bypass strict corporate controls and audits. Maybe it is because although the alleged total sum is large, broken down into $81.5 million annually and divvied up between hundreds of travel agents and other intermediaries, the amounts would be a fraction of GSK's annual Chinese turnover last year of $1.15 billion.

Clarifying exactly how all this was apparently kept off the books or completely hidden will yield critical lessons for international firms. Given that the payments were related to potentially legitimate looking travel expenses and educational conferences, would this have made it easier?

GSK, like most multinationals, has tough internal codes of conduct, clear whistleblowing mechanisms and a very detailed (nine-page) anti-corruption policy reviewed annually and assessed for effectiveness by an anti-bribery and corruption oversight committee that meets monthly. Being listed in both London and New York, the firm is also subject to the strict foreign corruption legislation of the UK and US.

The problem is that while such rules may be black and white on paper, on the ground for sales managers in China having to meet targets in a highly competitive market, there may be only shades of grey. Companies may have high central standards to which all global employees must adhere, but how can you ensure 100% local compliance?

Managers at foreign firms doing business in China face the need both to follow internal rules and domestic/foreign laws and find ways to compete with other companies who may be using less above-board ways to drive sales, creating a crevasse into which the GSK executives apparently fell.

The only effective remedy to this situation will come from taking away the opportunities for corruption in the pharma sector, which would involve huge systemic changes such as increases in the small salaries for state hospital doctors who now rely on kickbacks of a percentage of sales from their prescriptions to survive.

Medical facilities in general are highly dependent on income generated from the sales of drugs given cutbacks in state funding in recent years, creating bribery opportunities all down the supply chain. In a vicious circle, this drives irrational use and drives up drugs bills.

The final outcome of all this will probably be fines and possibly prison sentences under Chinese law for those convicted of any wrongdoing. The broader international legislative aspects and any liability under these have yet to play out.

But the firm is clearly adopting the defense that it was not aware of any illegal activity at higher levels, implying that it may have to fill any holes found in compliance procedures. By proactively admitting transgressions and taking aggressive remedial actions, the hope may be to minimize any penalties under the US Foreign Corrupt Practices Act, as Pfizer successfully did.

In the meantime, you can bet there are a lot of pharma firms scrabbling to tighten their oversight in China, evidenced by some multinationals already cutting links with one of the travel firms involved in the GSK affair. Which is maybe exactly the outcome China's government wanted when it initiated the GSK investigation.

Past columns are available at scripintelligence.com/asiabeat.