All parties are still trying to determine where they stand after the Supreme Court ruled June 17, on a case centered on what the Federal Trade Commission calls “pay to delay.” Unless you follow the pharmaceutical and biotech sectors, it’s likely that you’ve never heard of pay to delay. As a consumer, it might give you another reason to move pharmaceutical companies a little higher on your list of most hated industries.

Why all the debate about branded drugs?
The big drug companies like Pfizer (NYSE:PFE), GlaxoSmithKline PLC (NYSE:GSK), and Novartis (NYSE:NVS) invest a lot of money into new drugs. Exactly how much is the subject of wildly differing figures. According to the Pharmaceutical Research and Manufacturers of America (PhRMA), an industry group that represents branded drug companies, it takes about $1.3 billion to bring a new drug to market. (in 2005 dollars). 

Another widely quoted study found the median R&D cost to be $43.4 million. Pharmaceutical companies won’t release figures and even if they did, it would still be difficult to quantify the cost in accounting terms. There’s no doubt that the investment is high considering that most researched compounds will never make it to market. 

SEE: The Ups And Downs Of Biotechnology

For this reason, drug companies have an interest in protecting their revenue stream as long as possible. Their biggest adversary isn’t shrinking demand or competing branded drugs. It’s generic manufacturers who pounce on the branded product and release a generic as soon as the patent runs out.

These include companies like TEVA (NYSE:TEVA) and Actavis (NYSE:ACT). When a generic equivalent comes to market, the branded product’s revenue is often slashed in catastrophic proportions. Some times 75 percent or more.

Branded drug companies have to construct their pipeline in order to keep a constant stream of profitable drugs on the market. As one comes off patent, there’s another about to be launched. This is why M&A activity in the pharmaceutical sector is so frequent.

Pay to Delay
Over the past four years, a new way of protecting profits has gained popularity. Instead of planning to lose nearly all revenue once the drug goes off patent, the company owning the patent will pay generic manufacturers--often in the tens of millions of dollars, to delay the release of the generic form of the drug.

Often, generic manufacturers challenge the branded company’s patent rights in court where a settlement is struck. Some experts argue that these lawsuits are filed for the sole purpose of the companies masking an already-agreed-upon agreement in a legal settlement. The FTC calls it “pay to delay.” Of course, drug companies don’t use that label.

According to a recently published study by Dr. Farasat Bokhari, a health economist in the School of Economics and ESRC Centre for Competition Policy at UEA, in 2005 there were three of these agreements. In 2009, there were 19; 2010-31 agreements, and in 2012, there were 40 agreements in the United States alone. The same trend took place in Europe. 

However, are these agreements hurting the consumer? According to the FTC, pay to delay deals costs U.S. consumers $3.5 billion per year by delaying generic equivalents that sell for a fraction of the price of their branded equivalents. 

Bokhari’s research indicates that when a pay to delay deal is struck, the percentage increase in prices is 4 to 4.5 times higher than when the branded and generic companies jointly set the price. 

The Supreme Court
In legal terms, these agreements were reached to settle a patent dispute but the FTC sees them a violation of antitrust law. It petitioned the courts to overturn the agreements. 

What started in the lower courts made its way to the Supreme Court. The case was Federal Trade Commission v. Actavis, et al. In 2007, testosterone drug, Androgel, was set to lose about 75 percent of its profits. Solvay, the maker of the drug, “settled” a patent dispute with Actavis and two other generic manufacturers for $42 million, which kept the drug out of the hands of the generic manufacturers. 

The FTC took it to the Supreme Court hoping that it would rule that all pay to delay deals were illegal under antitrust law. Drug companies were hoping that it would rule that they were legal.

The Supreme did neither. In what was largely a win for the FTC, the court said that such agreements might be illegal under antitrust law. This meant that pay to delay deals could now be challenged under antitrust law instead of patent law making them more likely to be ruled unlawful. Neither side is happy.
PhRMA said, “…we are disappointed that the majority failed to provide clear and unambiguous guidance as to how patent settlements could be structured to avoid antitrust exposure short of litigating a patent dispute to the end.” 

FTC Chairwoman Edith Ramirez said, “We look forward to moving ahead with the Actavis litigation and showing that the settlements violate antitrust law. We also are studying the Court’s decision and assessing how best to protect consumers’ interests in other pay for delay cases.” 

SEE: Pharma Patent Trolls: Cheap Drugs At A Steep Price

Take Action
The FTC was much more a winner than the pharmaceutical industry, but since the Supreme Court didn’t rule decisively on the legality of these claims, each case will have to be tried separately at large expense to taxpayers and pharmaceutical companies. While the recent ruling will likely reduce the amount of pay to delay agreements, big pharma will continue to rely on a robust pipeline of new products through R&D efforts as well as M&A. The market response to the ruling has been muted with Actavis only down about 2 percent in the three days following the ruling.

Disclosure: At the time of this writing, Tim Parker had no position in the companies mentioned but his wife is an employee of Actavis.

Related Articles
  1. Stock Analysis

    Will J.C. Penney Come Back in 2016? (JCP)

    J.C. Penney is without a doubt turning itself around, but that doesn't guarantee the stock will respond immediately.
  2. Stock Analysis

    4 Reasons Gilead Sciences Should be in Your Stock Portfolio

    Discover how Gilead Sciences fits into most investment portfolios and learn about the company's drug pipeline and future growth catalysts.
  3. Stock Analysis

    The Biggest Risks of Investing in Pfizer Stock

    Learn the biggest potential risks that may affect the price of Pfizer's stock, complete with a fundamental analysis and review of other external factors.
  4. Stock Analysis

    Allstate: How Being Boring Earns it Billions (ALL)

    A summary of what Allstate Insurance sells and whom it sells it to including recent mergers and acquisitions that have helped boost its bottom line.
  5. Options & Futures

    Cyclical Versus Non-Cyclical Stocks

    Investing during an economic downturn simply means changing your focus. Discover the benefits of defensive stocks.
  6. Investing Basics

    How to Deduct Your Stock Losses

    Held onto a stock for too long? Selling at a loss is never ideal, but it is possible to minimize the damage. Here's how.
  7. Economics

    Is Wall Street Living in Denial?

    Will remaining calm and staying long present significant risks to your investment health?
  8. Stock Analysis

    When Will Dick's Sporting Goods Bounce Back? (DKS)

    Is DKS a bargain here?
  9. Investing News

    How AT&T Evolved into a Mobile Phone Giant

    A third of Americans use an AT&T mobile phone. How did it evolve from a state-sponsored monopoly, though antitrust and a technological revolution?
  10. Stock Analysis

    Home Depot: Can its Shares Continue Climbing?

    Home Depot has outperformed the market by a wide margin in the last 12 months. Is this sustainable?
  1. Are UTMA accounts escheatable?

    Like most financial assets held by institutions such as banks and investment firms, UTMA accounts can be escheated by state ... Read Full Answer >>
  2. Can the IRS audit you after a refund?

    The U.S. Internal Revenue Service (IRS) can audit tax returns even after it has issued a tax refund to a taxpayer. According ... Read Full Answer >>
  3. How does escheatment impact a company?

    In recent years, state governments have become increasingly aggressive in enforcing escheatment laws. As a result, many businesses ... Read Full Answer >>
  4. What happens if property is wrongfully escheated?

    If your financial accounts, such as bank, investment or savings accounts, are declared dormant and the managing financial ... Read Full Answer >>
  5. How do financial advisors help you avoid escheatment?

    Financial advisors can help you avoid the escheatment of your financial assets by regularly reviewing all of your accounts, ... Read Full Answer >>
  6. Are 401(k) accounts escheatable?

    Typically, 401(k) plans are not subject to state escheatment laws because they are covered under the Employee Retirement ... Read Full Answer >>

You May Also Like

Trading Center