Pharmaceutical Commerce Roundtable in Print: Public Accounting Issues

In normal times and for most industries, accounting, auditing and tax issues tend to hum along in the background—a necessary but relatively quiet part of business management. But for the biopharma industry, and in these times of financial systems turmoil, accounting services are a central part of managing businesses. Rarely does a day go by when some federal or state regulatory agency begins a dispute with a biopharma company, thereby starting a process of audit and compliance negotiations. And financial services, especially capital sources that are the lifeblood of startup biotechs, are today a complex and sometimes ugly arena of business activity. So, for the biopharma industry, its accounting, audit and tax services are critical partners in the businesses’ ongoing success.

We’ve asked representatives of several of the leading US public accounting firms to comment on some of the key issues driving biopharma today. The commentators have these things to say about Washington healthcare reform; corporate integrity agreements (CIAs); fair market value (FMV) assessments; aggregate-spend reporting and other “sunshine” laws; and financial instruments.

1. Let’s start with the “news:” Congress has been debating passing far-reaching healthcare reform legislation. The near-term impact point for life sciences could be the “$80-billion deal” to reduce the costs of Medicare patients’ drug bills. How is the industry going to manage this rebate program? How will its terms be enforced by CMS, and what does the industry need to do now to prepare for it?

GHOSH: The two key themes that seem to resonate in the current House and Senate reform bills are lower costs and additional oversight. The house bill would require HHS to negotiate payments for a public-health insurance option that in the aggregate is not lower than Medicare and not higher than average rates paid by other qualified plans. In general terms, Healthcare Reform will effectively put discount pricing in place for sales that manufacturers have typically realized as “cash customers.” Furthermore, these discounts may be substantially less than typical commercial discounts. The provisions for additional oversight may cause the OIG and other federal and state enforcement agencies to focus further resources in oversight of pharmaceutical manufacturer pricing and contracting to government programs.

Both the Senate and House bills have provisions to provide additional discounts to Medicare Part D enrollees in the “donut hole.” There are also potential provisions that would allow CMS to negotiate prices (e.g., discounts, rebates, etc.) that may be charged to Part D plans effectively standardizing Part D price negotiations to ensure that there are pricing “floors” established for Part D providers.

For Medicaid, there are potential provisions in the Senate bill that would redefine Average Manufacturing Price so that the value of AMP would increase, thereby forcing manufacturers to increase their rebate payments under the program. Additionally, there are provisions that also increase the basic rebate percentage from 15.1% to 23.1%, further increasing the rebate payments under the program. Both bills also have provisions that would increase the rebate percentages for new formulations of existing drugs and also introduce rebate payments for drugs dispensed to Medicaid managed care enrollees (manufacturers may pay rebates to the plans and CMS/States).

Finally, the Senate bill currently expands the 340B program to include inpatient drugs and also extends eligibility of the program to other potential recipients.

PERISHO: In light of the Massachusetts Senate election, it remains to be seen how the health reform effort plays out in Congress, but irrespective of the status of this particular legislation, trends in Federal and state enforcement suggest that cracking down on fraud, waste, and abuse remain a strategic option favored by policy makers as they search for ways to shrink budgets and otherwise finance reforms, whatever form they ultimately take.

BLUMBERG/FEDERING: When final particulars are known and enacted, those components will need to be understood for their congressional intent and expectations. Then the regulatory process will begin. Regulations will be proposed, commented upon, and perhaps evolve before taking effect. It’s a dynamic process and always subject to further legislative tweaking. For the industry to prepare it must understand the particulars, these dynamics, congressional oversight interests, and then plan for and manage potential operational benefits and transitional risks.

2. A large fraction of life sciences companies have corporate integrity agreements (CIAs) in place with the Office of Inspector General, HHS. How are these agreements functioning in terms of both accomplishing regulatory goals, and keeping the subject companies operating successfully as businesses?

PERISHO: CIAs have lead to significant investments in IT and business process improvements. Companies have used these CIAs as opportunities to drive cultures of compliance and empower the Compliance office as a real business partner to the sales, marketing and legal functions. Employees and agents of these companies are being reminded of their to duty to bear in mind the reputation, financial, and operational costs that an organization can incur because of the pervasive intentional or careless occurrences of non-compliance. Companies can, and have been using these change opportunities to streamline and add transparency to business units which can drive profitability in the long term.

GREGORY: CIAs have been very effective at providing a mandate for prioritizing compliance efforts within an organization. In general, a CIA is simply a written agreement with the Government to maintain a compliance program, with associated reporting obligations and substantial penalties for noncompliance. CIAs are effective at getting the attention of both senior management and board members, which can help lead to shifts in corporate culture beyond the required changes in business practice.

In the more than ten years since CIAs have been a part of the settlement process, the core CIA requirements have remained largely unchanged. However, what has evolved is a set of specific CIA requirements designed to address the specific alleged conduct that led to the settlement — off-label promotion, pricing matters and relationships with doctors, among other activities. Most major pharmaceutical companies already have in place substantial compliance programs.

CIAs are also considered to be effective at accomplishing regulatory goals. There have been very few reported instances of significant compliance failures in a business area for which the organization is already under a CIA.

BLUMBERG/HARPER: CIAs have been successful in a number of ways. Many companies now have a more formalized compliance function and they have added more resources to their compliance organizations, particularly at the top, as is evidenced by the growing number of visible chief compliance officer appointments in the last year. We’ve also seen real change in how companies are approaching compliance including a great deal more rigor around the communication of compliance goals, policies and operational implications.

Concurrently, there’s been increased monitoring and incentivizing activities directed at supporting the compliance infrastructure, including IT enhancements and training, to ensure that the change sticks. In fact, there are a number of manufacturers that have developed compliance course training and have mandated that all employees pass a certification test. In short, compliance has become more “top of mind” and better baked into every aspect of a pharmaceutical company’s day to day operations. Many companies seem to have adapted well to the new normal — they are performing well financially and on other dimensions.

3. In the context of enterprise risk management (ERM), much of the published advice focuses on identifying risks. But how are companies succeeding in managing or reducing risks? Where are the “success stories?”

BLUMBERG/HOON: There’s been significant progress by many companies in the management of risk. The growing use of a three-tiered governance structure which includes embedding risk identification, decision making and management into operations; having a risk function to define policies, processes, tools and facilitate the communication process; and having an objective body to analyze operations to assess the risk management process; all are helping to drive increased accountability and oversight. But the biggest successes are coming from organizations that bring together complex risk and compliance activities in alignment with the corporate strategy and organizational culture. When the focus is on building a resilient organization, driven by a robust governance structure, level-appropriate reporting dashboards, and intelligent use of IT and data management, the typical output is an enhanced, consistent, transparent and operationally efficient risk management effort. This greatly facilitates the monitoring, reporting and communication of risk information to both internal and external stakeholders.

4. “Fair market value” (FMV) keeps popping up as a key issue in federal contracts and in financial arrangements with healthcare providers. Why is there so much confusion about this subject, and what should life sciences companies do to make FMV assessments a non-issue?

DROZDOWSKI: Fair market value (FMV) seems like an easy concept: It’s typically the value at which two parties agree to conduct a transaction. When there are market transactions taking place, FMV is usually readily determinable.

FMV starts to get more difficult to assess when there are other business activities between the two parties, when there are multiple deliverables within a contract and when the transaction is for a non-homogeneous item or service. These types of transactions may introduce judgment and subjectivity into the evaluation, with each party holding a unique judgment as to what the FMV is. For example, when transactions or contracts are priced at FMV or cost plus a profit margin versus a specific amount, judgment will be brought into the transaction as each party will need to make a determination as to what amount to bill and what amount to pay. Each party will need to have a basis for “their” price. This will usually entail looking to an index or other comparable transactions (“comparables”). In many cases there may be a lack of clarity as to what “costs” go into the costing pool, for example overhead and administrative costs.

The more specialized the service or item is, the more judgment will be needed to get from comparable to the specific item or service delivered. The lack of clarity around what constitutes “cost” also increases the level of judgment in the process. More clarity and specificity in the contracts could help lessen the gaps between what the parties feel is the appropriate amount to bill and pay.

COLAPIETRO: A fair-market value model may be used in some parts of the organization, but not in all, or may exist, but be inconsistent across different parts of the business. From a regulatory perspective the payments made to an individual HCP should be consistent and “fair” based on their qualifications and the services provided regardless of which part of the business is contracting with the HCP. Many companies have not aligned the payments they make to individual HCPs across the organization (Sales, Marketing, Global Commercial, R&D). As a result, Marketing may enter into a contractual arrangement with an HCP and pay them one “value” and the R&D organization may contract the same HCP for essentially the same service but pay them a greater “value.” Companies need to establish and/or revisit their existing FMV schedule, taking into account at least three major factors:

• Level of Influence (Global, National, Regional, Local),
• Specialty, and
• Credentials/Qualifications

They should then tier their FMV schedule accordingly so there is documented and transparent business rationale as to why an HCP with a higher level of influence, credentials and specialized training receives a larger payment than an HCP with less influence, fewer credentials and more generalized expertise. The FMV schedule should then be used consistently across the organization for similar contractual arrangements with HCPs so there is no discrepancy.

PERISHO: FMV assessments are intended to add a degree of objective analysis to business relationships and promotional activity. Introducing a fair value analysis into your transaction authorization process can be taken as an affront to an experienced business person’s judgment. If those professionals are coached on the budgetary value as well as regulatory value of these analyses, adoption can be much smoother and FMV will be viewed as a useful tool instead of an onerous burden. It’s also helpful to explain to the users of the analyses how they are constructed. Management may encounter resistance if they allow the idea to persist that the FMV study was not based on “real world” industry experience or data.

5. State-level regulatory programs are multiplying in number and complexity with “sunshine” laws for physician’s payments and the like. State-level enforcement of Medicare payments is also receiving increased attention. What advice can you give for managing state-compliance programs from a corporate perspective?

COLAPIETRO: Based on state, federal and local country legislation, there may be various disclosure/transparency related initiatives that exist across the enterprise including: Institutional Spend, Healthcare Professional Spend, State Reporting, Federal Sunshine, Clinical Trials, Medicare Payments, and ex-US disclosure efforts. Companies should look to establish an overall Transparency Governance framework as an umbrella to connect these initiatives to raise awareness across the enterprise, coordinate the efforts, establish consistency, and leverage synergies in establishing new and/or revising policies, processes, organizations, technology, communication and training. Aligning these disparate initiatives can provide additional business insight internally to the organization and enable companies to present a consistent, cohesive face externally.

ERDOS: Knowledge of state-specific laws is critical, as there are numerous variances in terms of what must be included and is required from each. Knowing the restrictions and requirements of state-specific laws will help a corporation determine what impact (if any) such laws have on its compliance practices. However, when looking at the specifics of these mandates, the impact on the pharmaceutical industry may not always be readily apparent.

To help maintain compliance, a pharmaceutical company should consider engaging legal counsel with expertise in such matters (if this knowledge does not exist in-house). Given the high volume of state and federal legislative activities associated with the life sciences industry, corporations should also routinely assess their compliance program to manage evolving laws.

Once the impact of state laws on a corporation’s current US activities has been assessed, the company should also consider implementing and revising compliance practices that address all primary legal requirements in an efficient manner. At the same time, companies must remain sufficiently flexible to accommodate variances. For example, many state laws require tracking and/or reporting of certain categories of company expenditures; however, the specific expenses to be tracked and/or reported can vary by state. Any mechanism that is developed for the tracking of company expenditures (made either directly or through third parties) should not only be efficient in tracking these expenditures but should also allow the flexibility to determine what is included or excluded in reports, thereby also allowing it to accommodate the current known requirements as well as changes in future state or federal laws.

BLUMBERG/HARPER: First, companies need to view these programs as fundamental new requirements that are here to stay. Second, organizations will likely need to implement infrastructure changes to their processes, information technology, policies, training, and other areas to comply, but these changes need to be carefully and thoughtfully planned. We’ve seen too many instances where a “band-aid” approach, involving coping tools strapped on at the end of the process, or on top of existing tools and techniques, robs an organization of the chance to optimize its processes around the new normal. These organizations are then left with complex systems that are often unsustainable and faulty.

PERISHO: As this trend continues, it may become increasingly necessary to ensure the organizations’ systems are automated to support reconciliation efforts. As state and Federal enforcement agencies and public interest groups update their IT and data surveillance capabilities, inconsistencies between publicly available reports could lead to increased scrutiny and an erosion of credibility. Businesses may be able to minimize this risk by harmonizing and/or centralizing data collection and reporting protocols, formats and personnel. Building systems flexible enough to address changes in regulations, product lines, business models and jurisdictions that result from M&A activity or organic growth can minimize costs and disruption.

6. While the recent financial-industries meltdown has made corporate finance a more challenging task, it has also put derivatives-type financing under a spotlight. Are there widely used “exotic” financial instruments or currency-exchange practices that the life sciences industry needs to re-evaluate?

DROZDOWSKI: How derivatives financing instruments are used by life sciences companies depends to some extent on the company’s size. Larger more established pharmaceutical and biotechnology companies usually are very cash flow positive and often use derivatives tools for risk management, including straight forward hedging. But while not specifically financing instruments, contracts that contain rights to acquire, license, partner, etc. assets in the future are sometimes found in technology-related agreements and may contain embedded derivatives requiring consideration, in particular as to consolidation evaluations.

Smaller companies, such as biotech companies without an approved product, will likely be more active in raising funds for itself and these funding opportunities usually come with more rights and features for the investor or creditor. Typical instruments used for this activity include convertible debt and warrants. Rights that are typical include down round protection, where a shareholder may get may get additional warrants or shares, or the conversion price will reset if future financing is at a price below the original price or conversion rate. This type of protection can be dilutive to existing shareholders. Board seats may also be relinquished in the process as well. The convertible debt instruments usually include a covenant with respect to the fair value of the convertible debt (if it trades) that if it is not within a certain percentage of the fair value of the common stock underlying the conversion on an as if converted basis then it could become callable. PC