Police Say Sexual Favors Spur $1.5 Billion Glaxo China Sales

GlaxoSmithKline Plc’s sales in China jumped 20 percent to about 1 billion pounds ($1.5 billion) last year, almost quadruple the pace of growth across its emerging markets. Police say bribes and sexual favors spurred the gain.

The drugmaker now faces allegations of economic crimes involving 3 billion yuan ($489 million) of spurious travel and meeting expenses, and trade in sexual favors, the Public Security Ministry said yesterday. The allegations are “shameful” and would be a breach of the company’s systems and values, Glaxo said in a statement.

Prior to a police probe that began last month, Glaxo embarked on a strategy that tripled its Chinese sales force to more than 4,000 people in three years as the U.K.’s largest drugmaker sought a bigger share of the market. As that expansion was ramping up, Chief Executive Officer Andrew Witty told analysts on a February 2010 conference call that controlling Glaxo’s operations in China was “not a trivial proposition.”

Bribes paid to hospitals, doctors and health officials contributed to the resulting gains in revenue, according to the ministry, which controls China’s police. If found guilty, Glaxo could be ordered to pay a penalty of $5 million to $10 million, according to estimates by Kepler Capital Markets based on fines paid in China for similar violations.

That’d be a fraction of its sales in China, the world’s fastest-growing major pharmaceutical market, said Fabian Wenner, a Kepler Capital health-care analyst in Zurich.

Reputation Damage

“While being involved in criminal offenses and associated with illegal actions is clearly damaging for GSK’s reputation, I doubt that this will be of material impact for the company,” Wenner said in an interview yesterday. “I haven’t spoken to any investor who is concerned about this yet.”

Glaxo fell 0.9 percent to 1,728.50 pence as of 11:50 a.m. in London trading. The stock has risen 29 percent this year, compared with a 17 percent gain in the Bloomberg Europe Pharmaceutical Index.

In a December 2009 business strategy briefing, Mark Reilly, head of Glaxo’s China pharmaceuticals business since 2009, described a vision to “deliver growth consistently above the market growth rate” in the country.

Glaxo would expand into hospitals in smaller Chinese cities and rural areas, build on its lead in respiratory drugs and vaccines, and “aggressively grow” its diabetes franchise, according to slides of Reilly’s presentation.

Julian Heslop, who retired as Glaxo’s chief financial officer in 2011, explained on a March 2010 conference call that the company had realized it needed more salesmen after examining the operations of other drugmakers.

Market Share

“I looked at China and I looked at the competitors and I plotted sales force size with market share and there’s an amazing correlation,” Heslop told analysts during the call. “The more salesmen, the more penetration of the country, the bigger the market share.”

Heslop said the analysis led Glaxo to realize it had made a “mistake” when it focused more on increasing profits in China than on increasing sales.

China’s accusations against Glaxo come a year after the company agreed to plead guilty and pay $3 billion to resolve U.S. criminal and civil allegation that it illegally promoted prescription drugs and failed to report safety data.

Pfizer, Lilly

Eli Lilly & Co. in December agreed to pay $29.4 million to settle U.S. Securities and Exchange Commission allegations that employees gave cash and gifts to officials in China, Brazil, Russia and Poland to win millions of dollars in business. Pfizer Inc., the world’s biggest drugmaker, agreed last August to pay $60.2 million to settle foreign bribery cases it disclosed to U.S. authorities involving alleged payments paid by employees and agents of subsidiaries, including in China.

“As GSK supplies a range of important drugs for public health, we doubt that there will be an enduring impact on its business in China,” wrote Deutsche Bank AG’s London-based analyst Mark Clark in a June 12 note to clients.

Glaxo and rivals face a potentially greater threat in China from a pricing investigation announced this month by China’s National Development and Reform Commission, the top economic planning agency, Clark said.

Price Cuts

“There have been suggestions that this could result in large price cuts for those products that are available more cheaply in reference countries abroad,” Clark said.

Glaxo’s revenue in China last year equate to about 3.8 percent of the company’s total, Chief Financial Officer Simon Dingemans said in an interview in May. The company’s emerging markets sales grew 5.6 percent in the period to 1.56 billion pounds, according to data compiled by Bloomberg.

Pharmaceuticals sales in China are projected to expand 15-to-18 percent annually through 2016, IMS Institute for Healthcare Informatics said in July last year.

The heritage of GlaxoSmithKline in China dates from 1908, the company said in a 2007 press release. It was one of the first foreign pharmaceutical companies to establish a joint venture in China, with six manufacturing sites there and investment of more than $500 million, according to its website.

“To boost the prices and sales volume of their drugs, the company has taken some illegal actions,” Gao Feng, head of the economic crimes investigations unit at the Public Security Ministry, told reporters in Beijing yesterday. “GSK’s marketing strategy includes many things that allow and even encourage bribery activities.”

The use of kickbacks is a key reason why drug prices are higher in China than they ought to be, Gao said.

Bribing Costs

“GSK takes a large portion of the profits from its drug sales in China to bribe government officials, medical associations, hospitals and doctors,” he said. “Expenses for bribery are ultimately being covered by the public.”

Glaxo will cooperate fully with the Chinese authorities in their investigation and take all necessary action required, the drugmaker said in yesterday’s statement.

“GSK shares the desire of the Chinese authorities to root out corruption,” the company said. “These allegations are shameful and we regret this has occurred.”

Executives Detained

Four senior Glaxo executives -- all Chinese nationals -- have been detained as part of the investigation, Gao said. Enforcement measures haven’t extended to expatriate staff, though “we can’t promise anything,” he said, adding that Reilly left the country on June 27 after his colleagues were detained.

Reilly returned to the U.K. on a routine, planned business trip and has been working from company headquarters on the response to the investigation, according to a person with knowledge of the matter who asked not to be identified because he wasn’t authorized to speak on the subject. The person declined to say when or if Reilly will return to China.

The drugmaker has been boosting its research and development presence in China. For example, it opened an innovation center to develop consumer drugs, and set up a unit testing botanicals, compounds extracted from herbs used in traditional Chinese medicine, to treat immune disorders.

Those efforts hit a snag last month, when the company announced that it fired its head of Chinese research and development. It was discovered that a paper the scientist helped write for the journal Nature Medicine contained data that had been misrepresented. A second individual resigned and three others were placed on administrative leave pending a final review, and the company requested the paper be retracted.

“If something like the scientific retraction had occurred in the U.S. or Europe, the company involved would just have said that a researcher made an error,” said Greg Scott, founder of Shanghai-based life sciences consultancy ChinaBio LLC, in an e-mail. “But it happened in China, so it affects the perception of the whole country.”

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