Pharmaceutical Product Diversion – An Ounce of Prevention is a Cure for Compliance

Despite the 1988 enactment of the Prescription Drug Marketing Act (“PDMA”) 21 U.S.C. § 331, et seq., the drug supply chain remains vulnerable to diversion.  Despite the PDMA’s goals to prevent the introduction and retail sale of substandard, ineffective, and counterfeit drugs, there are no regulations providing an industry-wide pedigree system to ensure compliance.  As a result, the pharmaceutical industry has no consistent policy or means to prevent drugs from being diverted from authorized primary channels into unauthorized, but seemingly legitimate secondary market channels.  These secondary channels are portals through which mislabeled, adulterated, expired, sub-potent, and counterfeit drugs enter the nation’s drug distribution system.[i]

Diversion takes myriad forms, but perhaps the most troublesome arises when drug products intended for specific markets (domestic or overseas) are sold to alternative, unauthorized markets.  Diverters abuse the distribution system, compromise public health, and expose the supply chain to infiltration by counterfeiters or criminal elements in a multi-billion dollar industry that has increased exponentially since 2011.[ii]  Diversion can also lead to improper storage of drugs, compromising drug efficacy.  In many instances, diverters repackage drugs that have passed expiration dates, thus leading to the sale of sub-potent drugs.  In recent years, diversion has resulted in the stockpiling of drugs leading to critical, and life threatening shortages, not to mention exorbitant pricing for badly needed drugs.[iii]

The situation is compounded by the fact that many drug makers do not have policies and procedures in place to prevent their products from being diverted.  In many instances, their pricing strategies create arbitrage opportunities for diversion.  In others, authorized distributors sell excessive quantities to retail pharmacies that may be diverting the products.[iv]  Even the insurance industry and other third-party payers have been accused on providing an inconsistent, and in some cases, nonexistent response to preventing and detecting fraud related to diversion.[v] Worse yet, drug makers may be aware that their products are being diverted, but marketplace competition leads them to turn a blind eye to it.  Finally, compliance professionals may not view diversion as a “compliance” issue.

In recent years, however, the FDA has recognized and publicly noted that pharmaceuticals that (a) have a high market value, (b) are high-priced, or (c) have high sales volume are more frequently subject to counterfeiting and diversion.[vi]  The FDA has also signaled an intent to target wholesale distributors and others who are engaged in conduct related to the manufacture or distribution of counterfeit drugs, or engaged in the manufacture or distribution of prescription drugs that “otherwise violate the Act or other laws” regardless of the type of drug or whether it falls under the FDA’s characterization of a divertable drug.[vii]

Effective track-and-trace technology is probably the most reliable means of combating diversion.  However, there is no broad consensus in the pharmaceutical industry as to which technology should be used, and Congress has yet to enact on any legislative requirements in that regard.[viii]  In 2004, the State of California enacted the first electronic drug tracking system, known as the California Pedigree Law, currently scheduled to go into effect on a staggered basis in 2015.[ix]  In fact, thus far, 25 states have passed or proposed laws and regulations implementing pedigree requirements with varying degrees of complexity.[x]  In the absence of FDA action and/or federal preemption statutes to address these state laws, drug companies and distributors will be forced comply with a patchwork of inconsistent, state-specific requirements.

The FDA has shown some interest in a form of track-and-trace technology, known as radio frequency identification (“RFID”),[xi] which can be incorporated into the drug products themselves to “secure the integrity of the supply chain.”[xii]  The newly formed Pharmaceutical Distribution Security Alliance, whose members span the U.S. pharmaceutical distribution system, has been working on drafting a proposed bill designed to serialize and trace individual units of medicine.[xiii]  However, for decades now, well-funded diverters have successfully thwarted any effort to require secondary market compliance with such a scheme.[xiv]

With no uniform technological solution in sight, pharmaceutical companies need to be proactive in combating diversion with a three-part strategy consisting of prevention, detection, and deterrence.[xv]  Of the three, prevention is the most critical, because it begins with viewing diversion for what it really is — a compliance issue that needs to be addressed from the outset through internal practices and procedures designed to enhance a drug company’s ability to identify and protect itself, consumers, and its brand from a multi-billion dollar diversion industry.  In the wake of the obvious public health risks and brand damage associated with pharmaceutical diversion, it is imperative that all of the players in the pharmaceutical industry – particularly manufacturers and authorized distributors – be vigilant in preventing pharmaceutical products from entering the gray market.  The key to prevention is due diligence.

Prevention begins with rigorous policies and standard operating procedures strongly supported by senior management.[xvi]  Integration of various units within a company will ensure organizational awareness of the potential for a problem and effective coordination to prevent, and even detect, diversion.[xvii]  This includes alignment of various teams, such as business, internal security, legal and compliance, and, where feasible the creation of internal task forces for those who have expertise in security, marketing, technical operations and brand protection.[xviii]  In fact, the alignment itself is a preventive strategy as diverters count on corporate silos to elude detection.  Thus, procedures should be implemented through thorough effective training of key employees.

For example, detailed questionnaires or checklists can be used to gather information about potential institutional purchasers such as hospitals, nursing homes, closed-door pharmacies, group purchasing organizations, pharmacy benefits managers or other potential purchasers.  Pertinent information should be verified both from the outset and at regular intervals.  Such information would include basics such as email and street addresses, the nature and class of trade, patient/customer base, anticipated volume, and retail component, if any, as well as proof of DEA registration and licensing.

Manufacturers should form cross-functional working groups of employees responsible for (a) assessing the diversion risk of certain products and (b) implementing a prevention strategy.  A key component of this is designating specific employees responsible for performing due diligence on particular business partners and monitoring the distribution of product during the business relationship.  The employees responsible for initial due diligence and ongoing monitoring should be trained in relevant compliance procedures, and on the appropriate use of checklists.  Red flags that suggest that a purchase is a diverter include corporate aliases, Post Office or drop-box addresses instead of street addresses, shared ownership of known diverters, public email addresses (i.e., gmail or yahoo), admitted retail components, internet-based business,[xix] or non-traceable payment mechanisms, such as cash, money orders, or letters of credit.[xx]  Blank spaces or a “non-applicable” response with no explanation signals the potential for diversion.  A key element in the distribution of certain classes of medications is the anticipated and historic volumes of purchases.  To the extent purchase volume far exceeds historic levels or initial expectations; this may raise a red flag of concern that should be monitored more closely.

Whenever possible, the purchaser’s premises and warehouses should be inspected.  If an on-site inspection is not possible or economically feasible at the outset, then it should be done as soon as practicable.  It is fairly simple to identify a pill mill or an “own-use” institutional facility that has inflated its patient count through an on-site inspection.  Even the realistic threat of an on-site inspection may be effective to deter some diverters from following through on the purchase.  Thought should be given to restricting new accounts to low purchasing thresholds until a relationship of trust is established.

“Own use” transactions involving deeply discounted sales to “closed-door” pharmacies or other institutions, require written contracts that include representations and warranties expressly acknowledging limitations on the distribution of the product.[xxi]  Other critical contract terms may include unlimited audit rights, injunctive relief, and liquidated damages, as well as an admission that resale of the products outside of authorized channels causes harm to manufacturer and consumers.  If product ends up being diverted, such terms provide the manufacturer (as well as a prosecutor) with legal means of pursuing the diverter.  Where the diverter is part of an enterprise, federal and state racketeering laws, both civil and criminal, may enable the drug manufacturer to seek punitive damages or other relief.  Such strategies can have a deterrent effect.  Thus, effective prevention strategies enable a pharmaceutical company to better detect and deter diversion

Until there are consistent and effective technological and legal means of shoring up supply chains through which legitimate drugs flow, the pharmaceutical industry should be focusing on a solid prevention program focused on due diligence.  In other words, and because the human health stakes are high, pharmaceutical product diversion is in essence a compliance issue that, with a coordinated and strategic prevention strategy, can effectively be combated by manufacturers and their distributors until such time as Congress or the FDA structures an effective and consistent technology platform designed to safeguard the pharmaceutical supply chain.

[i] See, e.g.,Donald deKieffer, Trojan Drugs: Counterfeit and Mislabeled Pharmaceuticals in the Legitimate Market, 32 Am. J. L. and Med. 325, 335-36 (2006).  Indeed, only days ago the Food and Drug Administration announced the arrival of a second batch of fake cancer drugs in the United States.  The fakes apparently passed through legitimate secondary market channels.

[ii] Mike Rozembajgier, Track & Trace Strategies (Apr. 9, 2012), available at

[iii] See e.g. Keith Goldberg, Pharmacies Targeted In Probe of Gray-Market Drug Sales, Law 360 (March 21, 2012) (discussing Congressional leaders sending letters to licensed pharmacies they claim are buying up drugs in short supply and reselling them on a gray market at marked up prices).

[iv] In February 2012, the Drug Enforcement Agency accused CVS Pharmacy and Cardinal Health, one of the nation’s largest legitimate pharmaceutical distributors of selling excessive amounts of the painkillers to a handful of pharmacies in Florida.  The matter is pending in the United States Court of Appeals for the District of Columbia.  See, e.g.,

[v] William J. Mahon, Prescription for Peril: How Insurance Fraud Finances Theft and Abuse of Addictive Prescription Drugs, Coalition Against Insurance Fraud, 47 (Dec. 2007), available at


[vii] See id. (citing 21 U.S.C. § 353(e)(1)(A) and 21 CFR Part 203 (including sections §§ 203.3(u) and 203.50)).

[viii] See Crack down on counterfeit drugs, Star Tribune (Minneapolis, MN) (Mar. 24, 2012) (discussing Congress’s weighing of various drug “trace and trace” proposals).   The strongest possible track-and-trace system currently being considered by Congress would entail affixing a unique serial number on each bottle or vial, and requiring distributors, pharmacists, and others in the supply chain to scan the number as it moves through the distribution process.  Id.

[ix] California Business and Professions Code, Chapter 9, Sections 4000, et. seq

[x] Arizona, California, Colorado, Florida, Georgia, Idaho, Illinois, Indiana, Iowa, Kentucky, Louisiana, Maryland, Mississippi, Nebraska, Nevada, New Jersey, New Mexico, North Dakota, Oklahoma, Oregon, South Dakota, Texas, Virginia, Wisconsin, and Wyoming.

[xi] Jessica Maziarz, Radio Frequency Identification Technology: How Arizona Can Prevent the Sale of Counterfeit Prescription Drugs, 40 Ariz. St. L.J. 1085 (Fall, 2008)

[xii] Sofia Bruera, Regulating Rogue Pharmacies Using RFID Tags, 2D Barcodes, and Biometrics, 9 Hous. J. Health L. & Pol’y 71, 85 (Fall, 2008).  Purdue Pharma’s model for tracking Oxycontin provides an excellent model for how technology can be used to trace a drug.  Stephanie Feldman Aleong, Green Medicine: Using Lessons From Tort and Environmental Law to Hold Pharmaceutical Manufacturers and Authorized Distributors Liable for Injuries Caused by Counterfeit Drugs, 69 U. Pitt. L. Rev. 245, n. 132  (Winter, 2007) (citing Hallie Forcinio, Tagging Tools to Provide E-Pedigree, Pharmaceutical Tech., Sept. 2, 2006, at 44, 44, available at 71131) (“Purdue Pharma’s system consists of ultrahigh-frequency (UHF) tags and readers, device management software, and data management software (Class 0 UHF tags and readers, Symbol Technologies, Holtsville, NY; device-management software, Northern Apex Software, Fort Wayne, IN; “Auto-ID” and “Event Manager” software from SAP AG, Walldorf, Germany). This system interacts with the company’s enterprise resource-planning system (“R/3 ERP,” SAP AG) and makes it possible to link each bottle of OxyContin to a specific case and pallet.”)

[xiii] See, e.g.,

[xiv] See, e.g., RxUSA Wholesale, Inc. v. Dep’t of Health and Human Serv., 467 F. Supp. 2d 285 (E.D.N.Y 2006), aff’d 2008 WL 269935 (2d Cir. 2008) (enjoining FDA from implementing pedigree regulation against secondary wholesalers).

[xv] Kathleen Dooley & Julie Ann Sullivan, Analysis of Pharmaceutical Product Diversion and the Gray Market: Cheaper Drugs, but at What Cost?, Healthcare Law Monthly (2010).

[xvi] Id.

[xvii] Id.

[xviii] See Ann Roberts Brice, Combating Counterfeit Drugs, Life Science Leader, 3, Mar. 2009.

[xix]  Internet-based companies are among the worst offenders and the hardest to monitor for potential diversion.  See Amy L. Cadwell, In the War on Prescription Drug Abuse, E-Pharmacies Are Making Doctor Shopping Irrelevant, 7 Hous. J. Health L. & Pol’y 85 (Fall, 2006).  At a minimum, companies should confirm that any internet-based companies they contract with are accredited by the National Association of Boards of Pharmacy and bear the seal of a Verified Internet Pharmacy Practice Sites (VIPPS).  See; see also FDA Consumer Update, The Possible Dangers of Buying Medicines Over the Internet (updated Feb. 27, 2009), available at www.fda/gov/ForConsumers/ConsumerUpdates/ucm.048396.htm.

[xx] Dooley & Sullivan, supra note 15.

[xxi] An “own use” discounted pricing program was discussed and sanctioned by the United States Supreme Court in Abbott Laboratories v. Portland Retail Druggists Association, Inc., 425 U.S. 1 (1976).


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