China’s investigation into the operations of UK pharmaceutical giant GlaxoSmithKline and other multinational drug companies shows that the government is serious about tackling corruption and commercial misbehavior. But it also exposed a rotten core in the nation’s medical system that needs to be addressed.

Earlier this month, the Ministry of Public Security detained four GSK executives and some related personnel in China, alleging they were involved in passing bribes totaling 3 billion yuan (US$484 million) to government officials, medical associations and foundations, hospitals and doctors.

The money, channeled through 700 third-party travel agencies, was aimed at expanding drug sales in China, the ministry said.

On Saturday, state media reported that at least 18 other people had been detained in connection with the corruption scandal.

“All companies should be subject to sanctions and take legal responsibility once Chinese laws have been violated,” Shen Danyang, a Ministry of Commerce spokesman, told a news conference earlier this month.

GSK has not denied the charges, saying that senior executives of the company working in China appear to have broken the law.

Chief Executive Andrew Witty said the situation was “shameful” and “deeply disappointing.” The company just days ago appointed Herve Gisserot to replace Mark Reilly as China general manager.

GSK operates a research and development center in Shanghai and six manufacturing sites in China. Its investment in China exceeds US$80.6 million, according to the company’s official website.

Dominant channel

Despite the high profile of the case, both in China and abroad, the revelations of wrongdoing are not expected to adversely affect drug industry operations in China, analysts said.

Provincial-level public health bureaus and drug administrative authorities are responsible for compiling the Essential Drug List and the Reimbursement Drug List, and medical insurance policyholders are reimbursed by the government for part of the price of every drug they buy, depending on the size of premiums they pay.

But doctors have the final say over what drugs are prescribed to patients. Hospitals remain the dominant channel for drug sales.

Sinohealth Intelligence pointed out in a research report that 74 percent of pharmaceutical sales emanated from hospitals.

One Shanghai pharmaceutical company agent, who used to sell imported cardiovascular drugs to local hospitals, said that paying for hospital department heads and directors to attend industry forums and take business trips is very common.

They are considered gate-keepers in the pharma trade.

Some drug companies also pay medical practitioners lecture fees to endorse use of certain drugs, said the agent, who declined to be identified. And, yes, there are cases when cash kickbacks are paid directly to doctors based on the number of drugs they prescribe, he added.

“This has been a widespread practice among drug companies and Glaxo’s practice is not uncommon,” he said.

The crackdown on GSK may result in tighter internal controls over multinational pharmaceutical businesses in China in the short term.

But in the long run, the companies are in a highly competitive business and will still chase the huge profit potential in China, a market which IMS Health projects could become the world’s second-largest by 2016 at more than 900 billion yuan.

Zhao Yi, a Shanghai Jianwei Law Firm attorney who has worked on dozens of corruption cases, said unlawful means of securing sales growth in China will remain as long as the competitive landscape remains so cutthroat and as long as sales channels remain dominated by state-owned hospitals. Players may simply become more cunning in their methods, he said.

Major drug companies have compliance departments to oversee business operations and ensure they adhere to local laws and regulations.

But Zhao said compliance departments aren’t involved in sales strategies and executives are savvy about how to avoid internal scrutiny by using affiliated companies or external vendors when misdeeds are involved.

There have been previous scandals involving the Chinese operations of multinational pharmaceutical companies, such as Johnson & Johnson and Pfizer, but they didn’t hurt the whole industry, said Chen Heng, senior pharmaceutical industry researcher at Dongxing Securities.

High drug prices

“The government has sent a strong signal of its determination to fight high drug prices and deepen medical system reform, which are among the top complaints of the Chinese people,” he said.

Essence Securities analyst Chen Guodong said he expects little impact from the GSK investigation, but the industry as a whole could suffer if the corruption crackdown extends to domestic drug companies.

Earlier this month, the National Development and Reform Commission said it was looking into excessive drug prices at 27 joint venture pharmaceutical companies and 33 domestic ones, including joint ventures with GSK, Boehringer-Ingelheim and local giant Sinopharm Group.

Last Wednesday, the State Council said it would reform drug pricing and procurement systems.

And for the first time, it said it would extend surveillance of medical institutions to include medical staff and their practices.

Government agencies taking part in the sweep include the ministries of public security and health, the National Development and Reform Commission, and the State Administration for Industry and Commerce.

The State Council’s determination to step up supervision reflects the country’s firm stance on fighting corruption and malpractice in the pharmaceutical industry and in hospitals, Xinhua news agency wrote in a commentary last week.

It said big international firms need to take responsibility and root out malpractices, and domestic pharmaceutical companies should regard the government’s pronouncements as a wake-up call.

Earlier this month, 39 employees at the People's Hospital of Gaozhou in the southern province of Guangdong were accused of taking kickbacks totaling 2.82 million yuan since January 2010, according to a National Health and Family Planning Commission statement.

The director of the local health bureau was given a warning and suffered “administrative sanctions,” while the hospital’s director was dismissed.

“Bribe-takers, whether they’re government officials or company executives, should also be targeted or it will set a bad example and people will think it’s just a smear campaign against multinational drug firms,” said John Tsang, executive partner at DFL Law Firm, who is also a legal adviser for several multinational drug firms in China.

Rampant corruption is often found in areas with the least government supervision, he said. “The government needs to show a firm attitude towards fighting corruption, and much more needs to be done to set up an effective mechanism to crack down on economic crimes.”