Coursework 2 Case 1 In 2000, Solvay Pharmaceuticals develops and markets AndroGel, an FDA approved treatment for low testosterone in males. The treatment is a topical gel and is the only approved topical testosterone gel approved in the United States. By 2006, two potential competitors are close to getting FDA and legal approval to bring generic forms of AndroGel onto the market. The generic drugs will have the same efficacy as the brand name drug but will be priced somewhere from 75 percent to 85% lower than AndroGel. As a result, the market share for AndroGel will likely decrease dramatically (with the generics estimated to get 80% of the market). However, prior to product launch, Solvay reached an agreement with the two generic manufacturers (Watson Pharmaceuticals and Paddock Pharmaceuticals). The agreement stems from a patent-infringement lawsuit brought by Solvay against Watson and Paddock. In the agreement, Solvay agrees to pay Watson and Paddock for not entering the market but rather agreeing to market AndroGel. The Federal Trade Commission files a lawsuit alleging that the payments to keep Watson and Paddock from entering the market are an illegal restraint of trade. Build up power point presentations to answer the following questions. These should be submitted in Blackboard. Questions What is the market structure prior to entry by Watson Pharmaceuticals and Paddock Pharmaceuticals? How would it change if Watson and Paddock entered with their generic versions? What would happen to prices, sales, and consumer surplus if the generic drug makers entered the market? Why was it beneficial for Watson and Paddock to accept the settlement instead of competing with AndroGel . Could other potential entrants seek payments from Solvay to stay out of the market? Case 2 Companies that establish prices on the NASDAQ stock exchange are known as market makers. Market makers facilitate trading by listing separate prices at which they are willing to buy and sell a particular stock. Brokerage companies have the option of buying shares at the listed prices on behalf of their clients. The difference between the price the market maker is willing to buy (bid price) and the price at which it is willing to sell (ask price) is known as the spread. The profit a market maker makes is based on the spread. Many of the market makers on the NASDAQ exchange appear to have created and implemented a system to prevent the narrowing of the spread. Narrowing the spread increases the risks and reduces the profitability of the market makers. Under this quoting convention, market makers only listed stocks in even-eighths, unless their own spread was less than ¾ of a point. By not listing in odd-eighths, spreads were more stable and higher than they otherwise would be, and market makers assumed less risk in buying and selling the stocks. The market makers enforced the convention by accusing violators of being “unprofessional” and threatening not to trade with them. The result of this convention would be that investors pay higher transaction costs for buying and selling stocks. Once an investigation into these actions was undertaken, the firms began listing their quotes in both even and odd-eighths. Continue your power point presentations to answer the following questions. These should be submitted in Blackboard. What role do market makers play in the trading system? How do they profit from this role? How do the market makers compete with one another? How does the NASDAQ quoting convention work? How do the market makers enforce the quoting convention? What elements are necessary to make a convention such as this work? Were these present in this case? What is the result of this type of quoting convention? Pay for Delay: AndroGel Avoids Competition1 The United States Federal Trade Commission (FTC) has filed suit against pharmaceutical company Watson Pharmaceuticals over its agreement with Solvay Pharmaceuticals to not market a generic version of Solvay’s drug AndroGel for nine years. In turn, Solvay paid millions of dollars to Watson (and another generic drug maker, Paddock Laboratories). The FTC alleges that this “pay for delay” payment scheme results in reduced competition and higher drug costs, and violates laws against the Restraint of Trade. Case Summary In the 1990s, a partner of Solvay Pharmaceuticals, Inc. developed a drug treatment for low testosterone levels in males, a condition known as hypogonadism. Their development efforts resulted in AndroGel, the first testosterone-gel product approved by the Food and Drug Administration (FDA). The FDA approved the drug in 2000, and awarded Solvay with a period of statutory exclusivity under the Hatch-Waxman Act. The HatchWaxman Act is a federal law dating back to 1984 outlining the process for generic drug manufacturers to be able to enter and compete in the market, while also maintaining periods of exclusivity to allow pharmaceutical companies to recoup investment in costly R&D. Solvay filed for a patent on the drug, which was granted in 2003. AndroGel’s success in the market drew the attention of generic drug manufacturers Watson Pharmaceuticals and Paddock Laboratories. In 2003, both Actavis and Paddock filed applications with the FDA for Abbreviated New Drug Applications (ANDAs). In so doing, they claimed that the patent issued to Solvay was invalid, and that they should be allowed to market generic versions of AndroGel. These generic drugs would have the same active pharmaceutical ingredient, and would be assured of providing no significant difference in quality, safety, and efficacy as AndroGel. Solvay sued Watson and Paddock for patent infringement. By 2006, AndroGel was Solvay’s top-selling pharmaceutical product, with U.S. sales of over $300 million. However, in early 2006, the FDA gave Watson final approval to market a generic version of AndroGel, which would have significantly reduced the profits Solvay was earning. The patent infringement lawsuit was still pending, but Watson and Paddock would soon be able to market their generic products. Prior to a definitive legal outcome, the parties reached a settlement in which Solvay would make payments to Watson and Paddock in exchange for their agreement to defer launching a generic form AndroGel until 2015. These payments were in the form of co-promotion deals, whereby Watson would agree to promote AndroGel to physicians, and earn a share of the profits. This sort of payment is referred to as a reverse payment agreement, since the patent-holder agrees to a settlement in which it pays the company it is suing (rather than the other way around). Solvay projected that the payments to Watson would be anywhere from $19 million to $30 million per year over the life of the agreement. Generic Drugs and the Regulation of the US Pharmaceutical Industry The pharmaceutical industry is a significant and heavily-regulated industry in the US economy. The Drug Price Competition and Patent Term Restoration Act of 1984 (known as the “Hatch-Waxman Act” after its sponsors), established the regulation of generic pharmaceuticals in the market. Prior to 1984, there were relatively few generic drugs, and the Congress sought to facilitate competition from lower-priced generic drugs, while maintaining incentives for pharmaceutical companies to invest in developing new drugs. A company seeking to launch a new drug must file a New Drug Application with the FDA demonstrating the safety and efficacy of the product. A company that is seeking to market a generic version of a drug files an Abbreviated New Drug Application (ANDA). If the company that made the original drug holds a patent, then as part of the ANDA the generic-maker must certify that the generic either does not violate the patent, or that the patent is invalid. The patent holder can then file a patent-infringement lawsuit against the generic manufacturer in order to prevent the generic drug from coming on the market. Generic pharmaceuticals entering into the market are typically priced significantly lower than name-brand pharmaceuticals. Prices then tend to fall even further when more than one generic producer provides a drug. Due to the lower prices, many health insurance plans and Medicaid plans have adopted policies to encourage the substitution of generic drugs over branded drugs in order to reduce healthcare costs. As a result, generic drugs typically capture a significant market share in a relatively short amount of time. Consumers save more than $10 billion per year by using generic drugs instead of the branded drugs. A 2007 study of retail drug stores indicated that the average retail price of a brand-name prescription drug was $119, while retail price for a generic prescription was $34. AndroGel Solvay Pharmaceuticals markets AndroGel as a pharmaceutical gel containing synthetic testosterone. Synthetic testosterone has been available in pharmaceutical form since the 1950s. Pharmaceutical gel products had also been around for decades. However, AndroGel was the first application of synthetic testosterone in gel form. Solvay did not develop the formulation for AndroGel, but licensed it from the Belgian pharmaceutical company Besins, which had developed its formulation. Besins licensed the exclusive rights to Solvay, and also manufactured it for Solvay once the drug received FDA approval. AndroGel was approved by the FDA in 2000 for treatment as a testosterone replacement therapy for men with low testosterone. Low testosterone is associated with advancing age, certain cancers, diabetes, and HIV/AIDS, and can result in fatigue, muscle loss, and erectile dysfunction. AndroGel sold very well in the US market, with annual sales exceeding $400 million by 2007. AndroGel was Solvay’s best-selling product, accounting for one third of Solvay’s U.S. revenue by 2007. The prescription prices far exceeded Solvay’s cost of obtaining the product from Besins, even when factoring direct expenses and marketing and selling costs. The result was that AndroGel was an extremely profitable product. In 2000, Solvay filed for patent protection relating to AndroGel. Since testosterone therapy had been around for decades, the patent was specific to the use of a particular pharmaceutical gel formulation containing testosterone and other ingredients in certain amounts. The US Patent and Trademark office issued Patent No. 6,503,894 to Solvay on January 7, 2003, which provided patent protection for the AndroGel formulation that would last until 2020. In May 2003, Watson and Paddock filed for approval with the FDA to market a generic version of AndroGel. As part of their application, they certified that the patent on AndroGel was invalid according to the guidelines outlined in the Hatch-Waxman Act. Solvay sued Watson and Paddock for patent infringement, a move which automatically delayed FDA approval of the generic drugs until January 2006. Threat of Entry By 2006, the lawsuits on the patent infringement case were still pending. Solvay was concerned that the generic products would soon be launched. Solvay estimated that AndroGel would lose 90% of its sales within a year of the launch of the generic product. The result would be that generic competition would cut Solvay’s profits by $125 million per year. Watson projected a similar outcome, forecasting that the price of the generic drug would be about 75% lower than AndroGel within a year of entry, and that generics would capture 80% of the market. Paddock estimated that the generic price would be as low as 15% of AndroGel’s retail price. Both Watson and Paddock began making investments to prepare to launch the generic versions of their drugs, including spending $750,000 on commercial manufacturing equipment to produce the drugs. In spite of the dramatic impact of the marketing of the generic drugs, Solvay did not pursue a court injunction against the competitors on the patent infringement case that would have prevented entry in the market. Settlement Negotiations Aware that entry by generic firms would dramatically reduce profits from AndroGel, Solvay sought a settlement with the two firms. In September 2006, Watson agreed to a “co-promotion agreement” in which Watson would receive a high share of the profits generated on sales of AndroGel to urologists, a group of doctors to which Watson would be responsible for marketing. In return, Watson would agree not to introduce a generic version of AndroGel until August 2015. The agreement was projected to result in expected payments of $19 million in 2007, and as much as $30 million per year by the end of the contract. Both companies would then file an agreement ending their patent infringement litigation. Similar negotiations occurred between Solvay and Paddock (who had joined in partnership with Par Pharmaceuticals). Solvay agreed to pay Paddock $12 million per year for promoting various Solvay drugs and serving as a back-up manufacturer to Besins. A Besins executive noted in an e-mail that the “backup manufacturer strategy [was] a partial way to compensate [Paddock] for not entering the market.” In addition, Paddock agreed to perform sales calls on physicians. Litigation The State of California and Federal Trade Commission filed a lawsuit in 2009 alleging that the agreements between Solvay and Watson and Paddock constituted illegal restraint of trade. Since Watson and Paddock were potential competitors prepared to bring generic competitors on the market, the agreement was harmful to competition. Further, the effect of the settlement was that prices remained significantly higher than they would have with entry, leading to significant consumer harm. The defendants responded that the settlement was the result of a legitimate pending lawsuit – a settlement which made all parties better off. Following rulings in U.S. District Court of California and the Eleventh Circuit Court, the case would eventually make its way to the Supreme Court of the United States. Quoting Convention of NASDAQ Dealers Prompts a Justice Department Probe2 NASDAQ The NASDAQ Stock Market, Inc. (NASDAQ) is the second largest securities market (measured by dollar value of trading) in the United States. NASDAQ market makers have offices in various states. Their market making activities, and the violation alleged, affect investors located throughout the United States. During the time period covered, the companies in question have traded substantial numbers of shares of NASDAQ stock across state lines in a continuous and uninterrupted flow of interstate trade and commerce. The activities of each company as described here have been within the flow of, and have substantially affected, interstate commerce. POTENTIAL VIOLATION The companies in question are major "market makers" in NASDAQ stocks. Market makers establish their NASDAQ quotes in a particular stock by simultaneously quoting prices at which they are willing to buy and sell particular NASDAQ stocks. The quote at which an individual market maker is willing to buy a particular stock is known as its "bid"; the quote at which it is willing to sell is known as its "ask." A market maker’s bid is always lower than its ask, and the difference between the two is known as its "dealer spread." There are at least two market makers in each NASDAQ stock. These market makers are purportedly independent and purportedly compete against other market makers, by, among other ways, quoting bid and ask prices on NASDAQ for particular stocks. The market maker’s bid-prices and ask-prices are organized and displayed on NASDAQ’s computerized quotation system. The market makers use this computer system to change and update their respective bid and ask prices and to continuously communicate their prices to the other market makers in particular stocks. At any given time, one or more than one market maker may have the best bid or ask price in a particular stock on NASDAQ. The highest bid price is known as the "inside bid"; the lowest ask price is known as the "inside ask." The difference between the "inside bid" (the highest price offered by any market maker to buy that stock) and the "inside ask" (the lowest price offered by any market maker to sell that same stock) is referred to as the "inside spread." Market makers earn money from the difference between the bid and ask, or the inside spread. Market makers therefore have an incentive to maintain wider inside spreads in NASDAQ stocks than would exist in a competitive market. The width of the inside spread in a stock has a direct impact on investors in NASDAQ stocks. The wider the inside spread, the greater the transaction costs for buying and selling NASDAQ stocks. Beginning at least as early as 1989, a common understanding might have arose among the companies listed in Appendix A companies and other NASDAQ market makers concerning, among other things, the manner in which bid and ask prices would be displayed on NASDAQ (the "quoting convention"). Under the quoting convention, stocks with a dealer spread of 3/4 point or greater are quoted in eveneighths (quarters). Under the quoting convention, market makers use oddeighth fractions in their bid and ask prices only if they first narrow their dealer spread in the stock in question to less than 3/4 of a point. The listed companies and other market makers may have reached a common understanding to adhere to the quoting convention. This understanding is evidenced by, among other things, the following facts: MARKET IMPACT The purpose and effect of the potential quoting convention has been to raise, fix, and stabilize the inside spread on a substantial number of NASDAQ stocks at a minimum of 1/4 point. The quoting convention has potentially had the following effects, among others: P rice competition among the companies in question in the purchase and sale of NASDAQ securities might have been restrained; I nvestors who have purchased or sold NASDAQ securities might have been deprived of the benefits of free and open competition in the purchase and sale of NASDAQ securities; and T he inside spread on a substantial number of NASDAQ stocks has possibly been wider than it would have been in a competitive market, resulting in higher transaction costs for buying and selling NASDAQ stocks. APPENDIX A: List of Companies Involved in the Suit Michael Baye and Patrick Scholten prepared this case study to serve as the basis for classroom discussion rather than to represent economic or legal fact. The case is a condensed and slightly modified version of the public copy of the Complaint of Violation Statement, Civil Action No. 96 CIV 5313, dated July 17, 1996 in the United States of America v. Alex Brown & Sons Inc., et al. It has been updated by Kyle Anderson, Michael Baye, and Jeff Prince. Kyle Anderson, Michael Baye, and Jeffrey Prince prepared this case to serve as the basis for classroom discussion rather than to represent economic or legal fact. The case was written using the public documents involving Case No. CV 09-598 MRP, Federal Trade Commission and The State of California v. Watson Pharmaceuticals, Par Pharmaceutical Companies, Paddock Laboratories, and Solvay Pharmaceuticals.