J&J Blames Staff Cuts, Pfizer Deal for Tylenol Recall Flood

Johnson & Johnson’s flood of product recalls last year stemmed from poor management, staffing cuts and breakdowns in integrating the consumer unit it bought from Pfizer Inc. (PFE), J&J said in court papers.

Top executives at the world’s second-largest health-care products company, though, aren’t to blame, J&J said in the filing.

The report by a special committee of J&J board members, filed in response to investor lawsuits, said the company’s McNeil unit suffered from “an adversarial relationship” between some quality-control and production staff as well as "an emphasis on production volume” over compliance. The panel urged J&J’s board to create a new regulatory and compliance panel.

Recalls have dogged J&J the past two years, led by the withdrawal of more than 40 brands of children’s Tylenol, Motrin, and other medicines with foul odors or faulty ingredients. The New Brunswick, New Jersey-based company shut one factory for an overhaul last year and signed a consent decree in March expanding U.S. oversight at three plants.

J&J’s consumer division “should have paid more attention to” quality issues “and exercised more management oversight of McNeil,” the committee said in a 122-page report filed in federal court in Trenton, New Jersey. “With reduced central oversight and tasked with implementing the Pfizer Healthcare acquisition, some McNeil employees may have lost focus and commitment to maintain quality standards.”

Lawsuit Response

The report was a response to lawsuits filed by investors last year who said J&J’s leadership missed a series of “red flags” about the quality problems, as well as allegations of kickbacks, illegal marketing of drugs and bribes paid to doctors outside the U.S.

While the lawsuits argue that J&J’s problems are systemic, the lapses “were largely confined to McNeil,” the directors’ panel wrote. “There appears to be no single cause for the developments at McNeil. Senior management never issued any directives to the effect that quality should be sacrificed for production; nor did anyone report to senior management that McNeil was in jeopardy of significant regulatory intervention because it was out of compliance.”

The committee found no evidence that Chairman and Chief Executive Officer William Weldon engaged in or was aware of any wrongdoing, according to the report.

Biggest Deal

J&J purchased New York-based Pfizer’s consumer health-care unit in 2006 for $16.6 billion, in what was then the company’s biggest acquisition. Pfizer is the world’s biggest health-care company by sales.

Shares of J&J gained 23 cents to $66.47 at 4 p.m. in New York Stock Exchange composite trading. The shares have increased 7.5 percent this year.

McNeil shut its Fort Washington, Pennsylvania, plant on April 30 last year, the same day it pulled 136 million bottles of over-the-counter children’s medicines tainted with metal flecks or containing improper levels of ingredients. The list of recalls has since grown to include contact lenses, artificial hips, insulin cartridges and prescription drugs across J&J’s 250 subsidiaries.

The Pfizer acquisition had “a major impact” on procedures at McNeil, adding more than 3,000 product categories for the subsidiary, the committee report said. J&J installed new manufacturing lines at Fort Washington and a Las Piedras, Puerto Rico, factory, “increasing the volume and complexity of their operations and distracting” from quality improvements.

Leadership Shuffles

At the same time, McNeil was going through successive leaders in rapid order “who may not have had sufficient understanding of what was taking place at the plant level,” the committee said.

“At the plant level, there seemed to be a lack of attention to product quality by some non-quality personnel,” leading to friction with those responsible for compliance, the committee found.

A 2007 restructuring may have exacerbated the situation, cutting staff at J&J’s corporate quality and compliance program by 35 percent. The reshuffling took away the corporate division’s authority to conduct unannounced audits at subsidiaries. A “virtual hiring freeze” the following two years also made it difficult for McNeil to add quality reviewers, the report found.

Averaging Scores

An internal program to assess J&J factories gave Fort Washington and Las Piedras low scores for their internal auditing procedures in 2008 and 2009, the report said. But those were averaged with better measures for other attributes and corporate leaders learned only of the top-line, positive scores for each facility, directors said.

When the board’s audit committee received a routine briefing from the consumer division in 2009, “there were no sites in the red zone.”

The report was written by four independent directors asked by the board to investigate the lawsuits’ allegations. Charles O. “Chuck” Prince, the former Citigroup Inc. chief executive officer, led the group, which included Anne Mulcahy, former CEO of Xerox Corp.; William D. Perez, former CEO of Wm. Wrigley Jr. Co.; and Michael M.E. Johns, chancellor of Emory University.

While the board was unaware of problems at McNeil as they developed, senior management acted aggressively once the issues came to their attention, the committee found.

‘No Red Flags’

“The board and audit committee devoted substantial amounts of time and effort to review compliance efforts,” they said. “There were no red flags or indications of systemic failure that were overlooked. As issues arose, they were appropriately addressed and resolved -- often with the expenditure of significant resources.”

In a statement today, J&J said its management “takes the shareholder concerns and criticisms very seriously.” The full board voted unanimously on July 18 to adopt the committee’s recommendations, said Carol Goodrich, a spokeswoman.

Douglas Eakeley, an attorney for Lowenstein Sandler PC of Roseland, New Jersey, conducted the investigation for the board.

The suing shareholders include the Minneapolis Firefighters’ Relief Association and the Hawaii Laborers Pension Fund. They’ve asked a judge to order top executives and directors to pay damages to the company for mismanagement and to adopt new corporate governance procedures.

An attorney for the shareholders, New York-based Jeroen van Kwawegen, declined to comment in a telephone interview.

The case is In Re Johnson & Johnson (JNJ) Derivative Litigation, 10-cv-2033, U.S. District Court, District of New Jersey (Trenton).

To contact the reporters on this story: Alex Nussbaum in New York anussbaum1@bloomberg.net; David Voreacos in Newark, New Jersey, at dvoreacos@bloomberg.net

To contact the editors responsible for this story: David E. Rovella at drovella@bloomberg.net; Reg Gale at Rgale5@bloomberg.net.

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