Martin Shkreli Was Too Honest
FTC Chair Lina Khan just put the business model of big pharma on trial with a challenge to a merger of Amgen and Horizon Therapeutics. And Wall Street is freaking out.
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Today’s piece is about the wave of shock and fear that just came over the pharmaceutical industry. On Tuesday, the Federal Trade Commission challenged the $27 billion merger of Amgen and Horizon Therapeutics. In doing so, FTC Chair Lina Khan is putting the current business model of big pharma on trial, and trying to move drug discovery back to the center of the industry.
Before I get to that, I’d like to tell you about two significant legal victories for the anti-monopoly movement. First, the Antitrust Division won a major case today forcing JetBlue and American Airlines to dissolve their agreement known as the Northeast Alliance, which was a quasi-merger between the two airline giants. I’ll have more in the Sunday monopoly news round-up, but the decision by Judge Leo Sorokin is very good.
Second, a few weeks ago, I wrote a piece highlighting how a new Biden judicial appointee, Judge Ana C. Reyes, acted in dangerous ways during a merger trial. Anti-monopolists have been concerned about the courts for some time, not just the Supreme Court, but the lower courts as well, which routinely defer to corporate power.
Some of us started looking into a controversial Biden appointee - Michael Delaney - who was nominated for a circuit court slot. Circuit court judges, one step below the Supreme Court, are immensely powerful, the magistrates who quietly control our laws. For instance, a circuit court recently dismissed an antitrust case against Facebook. Delaney had significant problems as a nominee, notably he engaged in seemingly unethical behavior while defending a boarding school against a young sexual assault survivor. He was also ideologically opposed to a robust enforcement of anti-monopoly rules.
Earlier this week, a number of civil society groups - including mine - asked the Senate Judiciary Committee to reject his nomination. The next day, Delaney withdrew his candidacy for the slot. That’s a lifetime judicial slot that won’t be occupied by someone with an undue deference towards corporate power. It’s these kinds of below-the-radar political fights that structure how our society is organized. So… thumbs up!
Don’t Speak About Unspoken Truths
In 2015, 32 year old Turing Pharmaceuticals CEO Martin Shkreli became, temporarily, the “most hated man in America.” Dragged before Congress and pilloried in the media, Shkreli seemed to revel in his infamous nickname, Pharma Bro. Donald Trump called him a “spoiled brat” and Hillary Clinton accused him of price gouging.
Shkreli’s bad act was that his company bought the American marketing rights to Daraprim, an off-patent drug used by AIDS and cancer patients. Then he raised the price from $13.50 a tablet to $750, a 5000% price hike.
When Shkreli did the Daraprim acquisition, it was such an old medicine that the patent had run out. But Shkreli realized he could monopolize it anyway, and took steps to stop competitors from entering the market. He did a deal to make it extremely difficult for potential generic firms to acquire samples they might use to copy it, and monopolized the supply of a key input needed to produce the drug. When he raised the price, it was shocking, and no one could do anything about it.
"If there was a company that was selling an Aston Martin at the price of a bicycle,” he said in defending the price hike, “and we buy that company and we ask to charge Toyota prices, I don't think that that should be a crime."
Unlike most pharmaceutical executives, Shkreli didn’t pretend to be a scientist. He looked young and flaunted his wealth, spending $2 million on the only physical copy of the Wu-Tang Clan’s album Once Upon a Time in Shaolin. Eventually, Shkreli was sent to prison. Then, a judge fined him $64 million for monopolization and banned him for life from the industry. The industry’s main lobbying group, Phrma, disavowed him, and Shkreli was perceived as a bad apple, not as indicative of larger trends.
What Shkreli did was indeed outrageous, harming patients who needed life-saving medicine. But Shkreli also threatened to hurt the pharmaceutical industry itself, directly contravening the narrative by which firms in the industry define themselves. Pharma execs pretend to be scientists who bring miracle cures. Drug companies charge a lot, yes, but they do so because it’s expensive to develop drugs. Here, for instance, is Pfizer’s home page, which emphasizes science, risk, and ‘revolutionary medicines.’
Martin Shkreli’s story seemed to be just a flash in the pan. Pharma mergers and pricing games continued, unaffected.
Fast forward eight years later, to this week.
The Martin Shkreli-fication of Big Pharma
On Tuesday, the Federal Trade Commission filed a lawsuit to block the $27 billion combination of the biotech giant Amgen and Horizon Therapeutics. On first blush, this deal doesn’t seem to have any analogies with Shkreli. Amgen CEO Robert Bradway and Horizon CEO Timothy Walbert are balding or have grey hair, and both seem serious.
And when enforcers intervened, this time, the industry stepped up to defend its own. Pfizer’s development chief, not a party to the deal, told the Financial Times that stopping this transaction could be a disaster for drug development. “If you can’t get those M&A [deals] and then get those molecules distributed across the globe, it stifles innovation for sure,” said Pfizer’s William Pao.
There are two narratives for pharmaceutical mergers. The first is the standard one in the industry, which is that small biotech firms do the innovative drug discovery, and then get acquired by big firms like Pfizer or Amgen with the capital to do large scale testing, get regulatory approvals and do the necessary distribution. This narrative is one of scientific advance, where everyone is in an ecosystem to bring medicines to market. The second is the narrative Martin Shkreli highlighted, where a pharma firm buys an already existing medicine so that it can simply hike prices or otherwise engage in some form of extractive scheme. There’s no science here, it’s just financial engineering to acquire a portfolio of intellectual property to use as bargaining leverage.
For decades, the FTC did not try to distinguish between these two types of mergers, but let all of them go through. You couldn’t have two companies making similar medicines for a disease combine, but other than that, there were no restrictions. What this enforcement policy missed is that large pharmaceutical firms don’t do drug development anymore, they are by and large middlemen who harvest the intellectual property developed by others.
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Indeed, because of this policy framework, large firms actually changed their business models, managing big portfolios of drugs instead of trying to develop new ones. When a patent couldn’t be extended anymore, these firms would just buy smaller firms that had patented drugs on the market.
Indeed, we are now in a pharma merger boom. As Bloomberg’s Michelle Davis wrote, “Big pharma acquisitions had been speeding up, Big Pharma is on the hunt for safer, later-stage biotechs with products that can help replace revenue as blockbuster drugs go off patent later this decade, wiping out an estimated $200 billion of sales.” So in fact, Shkreli was doing something common in the industry, taking a neglected old drug he didn’t create, calling it a ‘specialty drug,’ and in the process raising the price to egregious levels. His true crime, as it turns out, was speaking aloud the unspoken truth of the industry.
In 2019, FTC Commissioner Rohit Chopra broke the silence among regulators on this point, dissenting from a pharmaceutical settlement, making the case that enforcers weren’t seeing big pharma firms as what they were, portfolio management companies instead of drug development firms. And what Chopra noted at the time was not a controversial statement except at the FTC. It was in fact well-known in the industry. Industry analyst Jared Holz, who works for pharma firms, said it straight-up on CNBC, “The large cap pharma companies are marketing machines, and so much of the other drug discovery and innovation is happening in the [smaller firms].”
Chopra’s dissent was an attack on the industry structure. Most people who think about medical costs assume that it is patents - a legal grant of monopoly power - driving up prices for drugs. But that isn’t quite the full story, as we see with Shkreli. One of the dynamics in American medicine is that dominant middlemen and dominant pharmaceutical firms often collude to prevent rivals from entering the market, thus keeping prices higher. A small pharmaceutical firm with a compelling treatment for, say, diabetes, will have a tough time getting its medicine onto the shelf to compete with Eli Lilly, simply because Eli Lilly has a big portfolio of pharmaceuticals, and it has deals with middlemen - such as pharmaceutical benefit mangers, health insurance firms and drug wholesalers - to keep rivals off the shelf space it uses. (There are many other games these firms play, my organization just released a report showing how this kind of cheating costs each over $115 a year for every person in America, or about $40 billion total.)
But until Chopra’s dissent, antitrust enforcers had tended to look at these kinds of bundles not as problematic but as efficient. Large pharmaceutical firms and large middlemen, by cutting special deals, must be reducing prices and increasing innovation, enforcers imagined. After all, the big firms said so. Here’s Horizon Therapeutics: “Our mission to deliver medicines for rare, autoimmune and severe inflammatory diseases and provide compassionate support comes from our strong and simple philosophy to make a meaningful difference for patients and communities in need..” That doesn’t sound like Martin Shkreli at all!
And yet, Horizon Therapeutics is simply a much more successful version of Shkreli’s firm. One of Horizon’s first drugs was basically a combination of Aleve and Nexium, which are literally an aspirin and anti acid; Horizon sold it for $3,000 by engaging in corrupt marketing schemes, generating $450 million in revenue. Like Shkreli, Horizon CEO Timothy Walbert’s strategy was not drug development but mergers and control of distribution. Horizon bought their lines of business, and then found ways of hiking prices. That’s also true of the acquiring firm, Amgen, which has a range of blockbuster drugs that it acquired. (Indeed, one way to know that the pharma business has been Shrekli-fied is that Amgen openly noted on its press releases announcing mergers that the key goal was to get blockbuster drugs already being sold on the market.)
Basically, both Amgen and Horizon are large-scale versions of Turing Pharmaceuticals. The FTC’s claim is that Amgen is buying Horizon to get access to two monopoly drugs - Tepezza, which treats certain eye diseases, and Krystexxa, used for refractory gout. These drugs are enormously expensive; Tepezza costs $350,000 for a six-month course of treatment, and Krystexxa costs approximately $650,000 for an annual supply. Because of insanely high prices, there are smaller firms trying to develop rival treatments.
The FTC’s theory is that Amgen will pay off various middlemen to make sure that these new rivals can’t access shelf space, by bundling its current blockbuster drugs with Tepezza and Krystexxa. Essentially, Amgen will operate a bit like Disney saying to a movie theater chain, “if you want our Marvel movies, you have to put our smaller films on some of your screens as well, and you must exclude movies from rival studios.”
This isn’t a speculative claim, because Amgen has a history of doing precisely this. In 2015, a rival firm, Regeneron sued Amgen, alleging that Amgen forced customers to favor its cholesterol treatment Repatha over Regeneron’s Praluent. As an inducement, Amgen gave better pricing “for its psoriasis drug Otezla and rheumatoid arthritis treatment Enbrel,” both of which were must-have treatments. The FTC is saying that Amgen will simply reprise this situation, as its financial models forecast continued monopoly pricing for Tepezza and Krystexxa.
A Shock to the Pharma System
And this brings me to the larger consequences of the merger challenge. When the FTC announced it was challenging the deal, the industry absolutely freaked out. Horizon’s stock fell 19%. The WSJ published an editorial titled Antitrust Gone Wild Against Amgen. Marc Engelsgjerd, a Bloomberg Intelligence analyst, argued that “there would be broad, negative implications for the biotech industry if this deal were ultimately blocked as exiting via acquisition is a standard practice and a common way for larger biopharmas to refresh their pipelines.”
The whole biotech index fell, with multi-billion firms that have drugs on the market being hardest hit. Seagan, Prometheus Biosciences, IVERIC bio, BioMarin, Alnulam, Sarepta all fell.
But it wasn’t all criticism - Regeneron’s CEO Leonard Schleifer backed the challenge, noting the transformation of the industry into a set of middlemen is bad long-term.
Schleifer said it can be hard to for a drugmaker get a treatment covered by payers if they are receiving “billions and billions of dollars” in rebates from a rival company. Drugmakers pay rebates to ensure their treatment is placed on the lists of drugs covered by insurance companies.
“I’m glad the FTC is looking at this,” Schleifer told the Financial Times US pharma and biotech summit in New York. “I think what goes on at the payer level is, in some respects, the worst thing for our industry and we’ve got to shine a brighter light on it.”
This case is part of a string challenges to the structure of the pharmaceutical industry. The FTC policy statement on insulin and PBMs is also about Martin Shkreli-ification, extraction over innovation. And the FTC isn’t alone. A whole host of state level officials are going at middlemen, and Congress has passed laws capping pharma prices, and will probably do something about pharmaceutical benefit managers shortly. It’s just that now the FTC explicitly stated big pharmaceutical firms that do little drug development are just one more layer of middlemen.
If the FTC succeeds in its challenge, the industry will have to confine its merger activity to smaller and useful acquisitions, where a firm with a product not yet on the market needs the expertise and capital of a bigger firm. That involves, however, big pharma taking on the risks of development, not just plugging holes in expiring patent portfolios with existing medicines. That would be an exceptionally good change, and would channel capital to drug development rather than financial games.
So what happens now? Both the FTC and Amgen have asked for a quick trial in August, and it will be heard by an Illinois judge, John F. Kness, a Federalist Society member who was appointed by Donald Trump but approved by Democratic Senators. Kness has no track record on antitrust, so we don’t know how he thinks about the problem. Regardless, this isn’t the last attempt to restructure the industry. After all, what was unusual about Shkreli’s situation, in other words, is that he was held accountable for what he did, because he was more honest that he was a hedge fund guy trying to get rich.
The last point I’ll note is that this move isn’t just about pharmaceuticals, but moving back to a more traditional model of running our commerce more broadly. In 1899, Henry Carter Adams, the illustrious economist and then-head statistician at the Interstate Commerce Commission, told the Chicago Conference on Trusts, why America had a monopoly problem. “As railways discriminate in favor of large shippers,” he said, “they present a motive to shippers to become as large as possible.” No one can deny, he continued, that “discriminations in railway rates are important elements in the conditions that foster commercial combinations.”
Basically, Adams was saying that dominant middlemen - which at the time were railroads - create market power in all sorts of industries by giving some firms unequal treatment, aka picking winners and losers. When that happens, the big shippers and big railroads ended up colluding to box out the little guy. For much of the 20th century, building on very old common law that goes back centuries, many sets of laws were designed to address this problem, to force equal treatment in commerce, from railroad and shipping rules to antitrust laws the FTC is trying to use. But starting in the 1950s, a series of thinkers began arguing that unequal treatment by dominant firms was not only reasonable, but efficient. And they eventually won the debate in the 1980s.
This intellectual victory is why drugs are so expensive, and why many other aspects of our economy are out of whack. What the FTC, Congress, and a whole host of other policymakers are doing is to bring business back into balance, and re-tether the act of producing things to how investors put money to work. The level of anger and entitlement of Wall Street is pretty high, since they are being asked to change and be useful once again instead of extractive. But ultimately, the problem here is habit. And after a few years of legal restructuring, we’ll get back to making money by doing good, instead of operating as more passive aggressive versions of Martin Shkreli.
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As always,Thanks Matt for an in-depth analysis of the pharmaceutical industry. It is no coincidence that all the concentration in the industry was fueled in the 80’s when the Regan GOP mob started the 40+ years march to destroy the American economy. I would make a wild guess that most other nations that pay significantly less for prescription medicines than America never let the middle man take control. This has also been a major obstacle in the agricultural industry where the farmers are little more that sharecroppers to big AG and the middlemen.
Having what was just a feeling be verified and explained by your reporting has enriched my understanding of these monopolistic entities immensely. Thank you!