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Ontario Probes Costco: Drug Kickback Scheme or Bad Blood Over Failed Relationship?

By Rich Duprey - Apr 7, 2016 at 9:04AM

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Generic-drug maker says the wholesaler is engaged in an illegal pay-to-play scheme in Canada.

Generic-drug maker accuses warehouse club of improperly forcing it to pay kickbacks so its pharmacies would stock its drug atorvastatin. Photo credit: Costco.

If it walks like a duck and talks like a duck, does that means it's still a drug rebate kickback scheme?

Warehouse club Costco (COST 1.24%) is under investigation in Canada for allegedly trying to strong-arm generic-drug manufacturer Ranbaxy into paying it $1.3 million in rebates in exchange for carrying its drugs, a practice that's legal just about everywhere in North America except Ontario.

A Ranbaxy pharmacist secretly recorded a conversation he had with a Costco director that seems to suggest the wholesaler was trying to get the generic-drug maker to pay it more money in exchange for making sure its drugs stayed on Costco's pharmacy shelves. And since the pharmacist said Costco had no intention of halting its rebate policy in Ontario, he recommended Ranbaxy stop paying Costco any rebates, even those where it's legal, and that resulted in Costco's subsequently dropping Ranbaxy from its supplier list.

Now the Ontario College of Pharmacists, the regulatory agency north of the border for pharmacies, is investigating Costco to see if it violated the law.

To get pharmacies like Costco to carry their drugs, manufacturers often kick back to the pharmacies some of the profits they make off the prescriptions. A 2007 federal Competition Board study says drugmakers often pay pharmacies as much as 40% of the price they invoice, but it can also go as high as 80%. Payments have also included gift cards, travelers checks, prepaid credit cards, and concert tickets.

Investigations into rebates from generic-drug companies to pharmacies have gone on for years, with the likes of Teva Pharmaceutical Industries and Pfizer's Canadian subsidiary being scrutinized for making improper payments. Some pharmacists have even had their licenses suspended for accepting them.

In Ranbaxy's complaint filed with the OCP, the pharmacist said that although Costco collected millions of dollars in rebates elsewhere in Canada, it did an end run around the rules in Ontario by labeling them as fees for advertising, marketing, and supporting its health clinics. The pharmacist charged that Costco told him "the company that pays the most will win the most listings," and it was his view the wholesale club "has clearly improperly characterized rebates as marketing services and clinic services."

In 2014, the year before Costco ended their relationship, Ranbaxy reportedly paid the wholesale club almost $1.8 million in drug rebates for sales outside Ontario and another $1.3 million in fees in the province.

Costco denies the allegations and chalks it up to a disgruntled generic-drug company that lost out on a lucrative market at its pharmacies. It says the secret recording the Ranbaxy pharmacist made also includes exculpatory comments by the director, who also pointed out that a significant percentage of the drugmaker's business with Costco in Ontario was for a single drug, atorvastatin, a cholesterol-lowering generic version of Pfizer's Lipitor.  Because atorvastatin is available only in Ontario and not elsewhere in Canada, Costco says its director realized that's why Ranbaxy was unable to pay it more money and acknowledged that such payments in the province would be illegal.

Costco is off to a rocky start in 2016. It had to delay the switch of its credit card providers from American Express to Visa as the migration of customer data was taking longer than anticipated, which hurt the warehouse's earnings this past quarter, taking $0.02 per share after tax. It's also begun rolling back sales of tobacco products at a time when sales growth is slowing, a potentially risky move as it's facing higher costs because it's giving employees higher wages to stay ahead of the competition.

And depending on how the investigation in Canada goes, it could cause regulators to examine Costco's other relationships with drugmakers in the province, broadening the troubles the retailer is currently confronting.

While this investigation advances, investors may want to keep an eye on their Costco stock until they gain clarity into whether it was engaged in a pay-to-play scheme or Ranbaxy simply has a case of sour grapes.

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