China Squeezes Medical Products Suppliers

“Confess, ” Xu Xinyu, a division chief at the Chinese National Development and Reform Commission (NDRC), told executives of about 30 large foreign firms at a closed-door meeting on July 25, 2013 in a small hotel in Beijing.

Confess for Leniency

Xu reportedly told the attendees that half of the companies in the room were either being investigated or had been probed by the NDRC. Xu’s message, according to an exclusive August 21, 2013 Reuters story, was that, “If you put up a fight, I could double or triple your fines.”

The companies were being pressured to confess to antitrust violations and were warned against using external lawyers to fight accusations from regulators. Such brazen enforcement pressure might even make former U.S. Attorney Christopher Christie, of orthopedic deferred prosecution agreement fame, blush.

It was not reported whether among the companies attending the meeting were Medtronic, Inc., Johnson & Johnson, Zimmer Holdings, Inc. or Stryker Corp., who have all made acquisitions or formed joint ventures with Chinese orthopedic companies.

The meeting had been billed as a training session to mark the fifth anniversary of the anti-monopoly law. Officials from the Ministry of Commerce as well as the State Administration for Industry and Commerce (SAIC), a regulator in charge of market supervision, were also at the meeting.

According to the Reuters article, Xu’s comments were perceived as threatening and consistent with the approach taken by other officials in private conversations with companies in recent months.

One lawyer reportedly asked a question about the anti-monopoly law. Xu asked the executive to elaborate on his company’s practices so he could determine on the spot if it was in violation or not. The lawyer clammed up.

The NDRC is offering leniency for some companies in return for cooperation.

Price Fixing, Anti-Competitive Behavior

On August 7, 2013, the NDRC announced fines totaling a record $110 million against five foreign milk powder firms and one Chinese producer for price fixing and anti-competitive behavior. Three other milk powder makers were investigated but not fined because they carried out “self-rectification, ” the NDRC said at the time.

A Shanghai court recently ordered Johnson & Johnson to pay 530, 000 yuan ($85, 000) to a distributor who had sued the company for setting a minimum price the distributor could charge for surgical sutures. The company was found guilty of “vertical monopoly.” The court said the company caused the distributor to lose potential sales and made the award for lost profits.

“This case is a warning to companies that the Chinese government is increasing the intensity of anti-monopoly investigations, ” said Wang Xiang, a lawyer for the firm Orrick, Herrington & Sutcliffe.

Public Show

Chinese prosecutors, investigators and regulators have been on a very public reform tear lately in the shadow of the trial of ousted politician Bo Xilai. Bo, the 64-year-old former party chief of the southwestern city of Chongqing, has been charged with illegally receiving almost 27 million yuan ($4.41 million) and being guilty of corruption and abuse of power. Bo’s trial was one of China’s most political in decades.

The ruling party allowed almost real-time coverage of the trial to the population at large.

Device Utilization Scrutiny

In addition to increase enforcement of the anti-monopoly law, the government is looking at the use of medical devices in Beijing after determining that overutilization is taking place to increase profits.

John Tan, a lawyer with Reed Smith’s Global Regulatory Enforcement Group based in Shanghai, wrote on August 15, 2013 that the local Beijing office of the Ministry of Health (MOH) announced that it has started a three-month review of the use of high-value medical devices in Beijing.

A previous investigation had found continuing problems at hospitals with the misuse and overuse of medical devices to increase profits. The investigation is intended to strengthen hospitals’ management of the use of medical devices.

The MOH will also develop a database that will track the price and model of devices implanted in each patient, require hospitals to improve their purchasing management systems, and conduct periodic inspections of hospitals’ purchasing and management of medical consumables.

Health Care Enforcement

In the last two months, there have been criminal and administrative enforcement actions by the NDRC targeting the pharmaceutical sector. Additionally, on August 14, 2013 the State Administration for Industry and Commerce (SAIC) announced a new three-month-long investigation into the pharmaceutical and medical services sectors, targeting bribery, fraud and anti-competitive practices.

The government has issued a new code of conduct for health care providers and a new guidance on strengthening anti-bribery controls in public medical institutions. Authorities also issued regulations on the centralized purchasing of medical consumables and large scale medical equipment containing provisions that would exclude companies found to have engaged in commercial bribery from participation in centralized purchasing.

A 2012 U.S. government publication stated, “Corruption remains endemic in China.” In the health sector, bribery has become so common that the Ministry of Health has issued draft guidelines that may require both patients and doctors to sign a mutual non-bribery agreement before hospitalization.

New Leadership

Hansen Yuan, M.D., Ph.D. is the Past President of NASS (North American Spine Society) and ISASS (International Society for the Advancement of Spine Surgery), and currently the Editor-in-Chief of the ISASS Journal. Dr. Yuan, who has taught many Chinese spine surgeons, told OTW that this is a sign of changing Chinese leadership, starting with a new president.

In Dr. Yuan’s view, there is a new commitment to rid the system of fraud, abuse and improper payments to government and business leaders. Dr. Yuan also told OTW that the new commitment is beginning with leaders of hospitals and is changing the culture and the way that companies court doctors to use their products.

He doesn’t expect to see individual doctors prosecuted, but expects health care system leaders to be held accountable. The corruption problem has been characterized in the press as being systemic and the new Chinese leadership wants to be very public about changing behavior from the top down, added Dr. Yuan.

Medtronic’s Take

During a conference call with Wall Street analysts on August 20, 2013, Medtronic’s CEO Omar Ishrak was asked what impact the government’s actions are having on Medtronic’s business.

Ishrak replied: “In our view most of that is directed around go-to-market models using distributors, which we are looking at very carefully. It’s a market where we eventually have to have more direct presence with the customers themselves.” He said the company has traditionally gone to market using distributors, whom he called, “extremely necessary.”

“We are examining our distribution models very carefully. At the same time we’re working very closely with the government to help put in the investment so that health care in China can be dramatically improved.”

Legal Issues

Companies should be aware that success brings greater legal responsibilities.

According to a 50-page primer called, “Distribution in China – Legal Issues” from the law firm of McDermott Will & Emery, success in the China market leading to a “dominant market position” will immediately entail greater restrictions on the conduct of a company.

The McDermott paper outlines key legal issues for companies to consider when doing business in China. We’ve highlighted some of the current topics under the government’s microscope.

Anti-Monopoly Law (AML)

The law went into effect in August 2008 and performs substantially the same role as the European Union’s competition law and U.S. antitrust laws.

“Monopolistic conduct” is defined as including agreements, decisions or other concerted behavior that eliminates or restricts competition; abuse of a dominant market position; and concentrations such as mergers, acquisitions and joint ventures that may have the effect of eliminating or restricting competition.

The fines go up to 10% of a company’s annual revenues, confiscation of illegal gains and private damage actions in the courts.

Anti-Unfair-Competition Law (AUCL)

The AUCL was enacted in 1993 to encourage and protect fair competition, discourage unfair competitive acts, and protect the lawful rights and interests of business operators and consumers

AUCL operates together with the AML, the Price Law and other laws to regulate the ways that businesses are allowed to compete with each other.

Price Law

The law was enacted in 1998 to standardize price behavior in order to encourage the rational disposition of resources, stabilize the general market price level, protect the rights and interests of consumers and business operators, and promote the healthy development of the socialist market economy.

Anti-Corruption Law

Under China’s legal system, the laws governing commercial and governmental corruption fall under two categories:

• Administrative regulations, such as the AUCL and the Interim Provisions on Banning Commercial Bribery
• Criminal laws, mainly forbidding bribes to government officials

Foreign companies must also follow the anti-corruption laws of their home countries.

Dominant Suppliers and Dominant Distributors

Failure to comply with the additional legal duties to avoid abuse of a dominant market position can result in fines, confiscation of illegal gains and private damage claims for the abuse of dominance.

There is a presumption of dominance, and therefore additional legal duties, in the following situations:

• Market share is 10% or more, and the supplier and two other undertakings together have 75% or more of the market.
• Market share is 10% or more, and the supplier and one other undertaking together have 66.6% or more of the market.
• The supplier or distributor’s market share is 50% or more.

Further, if a supplier or distributor declares publicly that it is dominant or has a market share in which the presumption of dominance arises, China courts will assume that the supplier or distributor is in fact dominant.

Corruption and Bribery

The giving of incidental gifts such as mooncakes, bottles of wine, dinners and other relatively small gifts is normally deemed legal if it is for promotional purposes. However, gifts of cash or anything of value for an improper purpose, such as obtaining or retaining business, will generally be regarded as bribery and considered illegal.

“Official” bribery is an offer of property to a state functionary in return for a benefit or assistance in obtaining an improper benefit. Significantly, “state functionary” includes doctors or medical workers in a state hospital

Click on this link for the entire McDermott paper.

The regulatory climate of China is changing rapidly. New leadership has promised changes and has been very public with examples of their actions to clean up corruption. If you see Xu Xinyu coming, get ready to confess.