The Hidden System of Legal Kickbacks Shaping the U.S. Prescription Drug Market

In the United States, as in most other countries, it is illegal for pharmaceutical companies to bribe doctors or hospitals to prescribe their products. Those who get caught engaging in this sort of corruption can suffer severe penalties. For example, in 2020, the pharmaceutical giant Novartis agreed to pay the U.S. government almost $700 million to settle a case involving allegations that the company had violated the federal Anti-Kickback statute by offering “cash payments, recreational outings, lavish meals, and expensive alcohol” to doctors to induce them to prescribe Novartis drugs. Yet when pharmaceutical companies offer financial inducements worth billions of dollars to Pharmacy Benefit Managers (PBMs)—not the meager thousands spent on doctors—to promote use of their drugs, the conduct is entirely legal.

What, you may ask, are PBMs? Good question. Most laypeople outside the health care field are unfamiliar with PBMs, and may not even know they exist. But PBM’s play a crucial, if underappreciated and extremely complex role in determining prescription drug prices and insurance coverage decisions. Simplifying somewhat, PBMs’ primary function is to manage insurance companies’ prescription drug plans, a role that includes, among other things, negotiating with drug companies to determine which drugs insurance will cover, and which will be favored. Given that just three PBMs control over 80% of the prescription drug market, PBMs can have an enormous effect on pharmaceutical sales, as drugs that lack insurance coverage are significantly less attractive to consumers than those with coverage. Additionally, PBMs also reimburse pharmacies on behalf of insurance providers for the costs of filling beneficiaries’ prescriptions.

In short, PBMs, which stand in between many of the transactions in the pharmaceutical supply chain, play a major role determining the prices paid by insurers, pharmacies, and patients for prescription drugs. And although kickbacks to doctors, hospitals, insurance companies, and other actors in the system are strictly prohibited, drug companies can and do take advantage PBMs’ complex payment structures to discreetly offer financial inducements in order to gain PBMs’ favor during insurance coverage determinations. There are two main ways in which this de facto bribery occurs: Continue reading

The FDA Drug Approval Process Has Problems—But It Is Not Corrupt

Is the US drug approval process corrupt? Many critics say that it is, leveling the charged rhetoric of corruption at the Food and Drug Administration (FDA) (see, for example, here, here, and here). Yet there have been few, if any, credible allegations of illegal bribery or the exchange of quid pro quo benefits in relation to FDA drug approvals. Rather, when critics speak of “corruption” at the FDA, they are alluding to a perhaps all-too-cozy relationship between the FDA and the pharmaceutical companies it regulates. That is indeed a source of concern: Big business likely has too much sway in Washington, D.C. on a whole range of issues, and the FDA is not immune to the powerful influence of powerful lobbies like Big Pharma. Yet the casual deployment of the rhetoric of “corruption” in this context, though offering attractive click-bait, is both misleading and potentially counterproductive. Continue reading

Risky Wagers: How Lack of Oversight Increases the Odds of Corruption in Sports Gambling

Thanks to the internet, sports gambling—once limited to smoky back rooms and local bookies—has rapidly expanded, and this expansion has fueled growing concerns over the integrity of professional sports. Sports gambling has long been intertwined with sports-related corruption, but the sheer number of gambling transactions made possible by the advent of online betting (through both legal and illegal websites) substantially increases the likelihood that bribery or match-fixing will be used to ensure a “winning bet.”

National regulatory approaches have not kept up with the heighted risks. The United States, for example, continues to rely on outdated regulatory regimes and ill-defined responsibilities shared between state regulators, federal regulators, and professional sports leagues. As more and more states move to legalize sports gambling, the US is in urgent need of a centralized authority that possesses the necessary incentives and requisite capabilities to properly regulate this burgeoning industry.

To see why reform is needed, consider each of the three main actors (or sets of actors) that have some responsibility to deal with the integrity threats posed by online sports gambling in the U.S.: state governments, the federal government, and the professional leagues: Continue reading

Putting the G in ESG Investment: Incorporating Anticorruption into Investment Decisions

A growing number of investors now consider environmental, social, and governance (ESG) issues when making investment decisions. While ESG investment methods vary, typically ESG investment involves evaluating potential investments not only based on traditional financial indicators, like annual cash flows and debt levels, but also on a number of observable ESG criteria, such board diversity or use of renewable energy. Given the difficulty of establishing investment parameters that incorporate a wide range of sometimes competing objectives, however, ESG investors usually end up prioritizing certain ESG considerations over others. In particular, governance issues—including corruption-related concerns—have often fallen by the wayside (see here, here, here, and here), so much so that a joke in the field has it that the “G” in ESG is silent.

This is unfortunate. Investments tainted with corruption not only indicate a failure in corporate governance—which can reduce the investment’s expected profitability—but also can contribute to a plethora of grave social and environmental ills (see here, here, here, here, and here). Given the fact that an investment’s corruption risk is relevant to a range of social and financial objectives, why hasn’t corruption risk played a more prominent role in ESG investing?

The cynical explanation would be that ESG investing is nothing more than a marketing ploy, and that ESG investors are therefore more likely to tout PR-friendly topics, such as CO2 emissions, and neglect less flashy issues like corporate governance. But that cynical explanation is unpersuasive in light of the fact that ESG investors are spending heavily on efforts to obtain more comprehensive ESG data—behavior that is hard to square with the view that this is all for PR. More plausibly, the insufficient attention to corruption is not from a lack of concern, but rather from a lack in ability to properly assess corruption risk. Reasons for this shortcoming are twofold:

  • First, companies’ reporting on corruption varies significantly in terms of both the quantity and quality of information provided to investors. Without certain standardized disclosures, it is difficult to compare corruption risk across investments. Reliance on voluntary disclosures can allow for the corruption equivalent of greenwashing, where positive information is exaggerated and negative information is buried or completely excluded.
  • Second, even if companies report robust internal control policies, it is difficult for external parties to assess whether these practices are effective or actually utilized. Proper assessment of corruption risk requires internal information that is hard for investors to obtain on their own.

There are several possible things that government regulators, and the ESG investors themselves, might do to address these problems, thereby making it more feasible for ESG investors to take corruption issues more seriously.

With respect to regulation, financial regulators should require certain corruption-related disclosures, so that ESG investors could better engage in relative comparison between investments’ corruption risk. The required disclosures might include:

  • Detailed information on the company’s internal controls and chain of command, including the size and scope of the compliance department, the names the officers and board members responsible for oversight of the compliance program, and whether the company as an “ombudsperson” or independent reporting channel;
  • The number of alleged compliance infringements and the number of resulting disciplinary measures;
  • The company’s assessment (perhaps in the annual report) of the corruption risks it faces, including general risks associated with its line of business and, more specifically, the level of interaction it has with governments and public officials.

The ESG investors themselves can also do more to demand greater corruption-related information from companies and insist that this information be accurate and independently verified. Independent assessments by third-party organizations could ensure that impressive anticorruption reporting and compliance programs are not merely “lip service.” NGOs and consultants already engage in similar analysis of private sector corruption, and would be well-placed to perform such “corruption audits.” For example, Transparency International’s Defense and Security program assesses corruption risk for individual companies in the opaque private military and security industry. With sufficient demand from the growing ESG market—which has already large capital outflows from investments that fail to meet certain socially responsible investment parameters—this type of corruption audit could become an industry norm.

ESG investors have been able to exert meaningful financial pressure on companies, making them increasingly influential over corporate behavior (see here, here, and here). These investors could become a powerful force in combating corruption—if, but only if, they are equipped with the necessary information.

Greasing the Wheels: How Norway’s Sovereign Wealth Fund Ended Up Financing Russian Corruption

Norway’s Government Pension Fund Global (GPFG) is one of the largest sovereign wealth funds in the world. Established in 1990 to diversify Norway’s oil wealth and minimize negative consequences associated with fluctuations in commodities markets, GPFG has amassed close to $1.3 trillion in assets. In keeping with Norway’s sterling reputation for integrity, GPFG has embraced anticorruption as one of the fund’s guiding principles. In fact, GPFG requires the companies in which it invests “to identify and manage corruption risk, and to report publicly on their anti-corruption efforts.” The fund’s Council of Ethics has also declared that the fund will keep “gross corruption” out of its portfolio, and GPFG has been widely praised for its social responsibility (see here and here).

Yet despite all this, GPFG has not avoided corruption-related scandals, particularly with respect to its investments in Russia. Understanding how things went wrong offers more general lessons for how sovereign wealth funds can strengthen their safeguards against investing in corrupt companies and supporting corrupt regimes. Continue reading

Managing Corruption Risk in U.S. Public Pension Funds

Public pension funds provide retirement benefits for government employees, such as firefighters, teachers, and police officers. In the United States, the pension funds of state employees are typically managed by a board of trustees that is generally comprised of investment professionals, beneficiary representatives, and individuals appointed by state elected officials. (Fund governance structures vary somewhat from state to state.) These trustees then exert tremendous influence over the allocation of pension assets to different investment vehicles, such as private equity and hedge funds. While individual pension funds vary in size, the total amount of money involved is enormous: Public pension fund managers in the United States are responsible for allocating over $5.5 trillion in assets across different investment vehicles.

How pension managers select among different investment opportunities remains a largely opaque process. This lack of transparency—coupled with broad investment discretion—fosters a substantial risk of corruption. Such corruption can take several different forms:

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