Prescription Drug Law Fails as Antidote to Black Market : Fraud: Lucrative resale schemes thrive as the major players escape prosecution. Consumers foot the bill.

Martin Rubin was directing a highly lucrative, illegal enterprise out of his Las Vegas office in 1988 when then-President Ronald Reagan signed a new law intended to bring a halt to Rubin’s activities.

But Rubin did not panic. “I am assuring you that this doesn’t affect anything,” he told an associate, referring to the new law.

Six years later, even though Rubin has served a brief prison term on mail and wire fraud charges, it is clear that his assessment was essentially correct. Law enforcement officials say he remains a driving force behind what they characterize as a thriving, nationwide “black market” in prescription drugs whose total annual revenue sometimes has been estimated at $500 million.

By his own admission, Rubin has made a career of acting as the middleman in an operation in which small wholesalers fraudulently purchase pharmaceuticals from manufacturers at big discounts intended only for hospitals and nursing homes, and then resell them at huge profits to other wholesalers who supply retail drugstores.

Although there are many variations on the scheme, it often works like this: In the late 1980s, according to court documents, Rubin persuaded several small nursing home pharmacies in the Kansas City area to order large quantities of drugs on his behalf on a regular basis at cut-rate prices that were legally unavailable to him or any other wholesaler. To obtain the lower prices, the pharmacies had to pledge they would not resell the drugs.

The pharmacies then reneged on the pledge and sold the drugs to Rubin at a 25% markup. Rubin, who had now obtained the drugs illegally, passed them along to a major drug wholesaler at an additional 30% to 40% markup.

According to state and federal investigators, Rubin’s brand of business activity is flourishing despite the enactment of the 1988 Prescription Drug Marketing Act written by Rep. John D. Dingell (D-Mich.), which was hailed at the time as the antidote to black market prescription drug sales.

To date, none of the major players known to be reaping big profits in the prescription drug black market has ever been prosecuted under the new law. In fact, the Food and Drug Administration has yet to complete final regulations to implement it. This week in Mississippi, federal prosecutors will go into court to try their first case under the law against a defendant accused of black market activity.

Every user of prescription drugs has a stake in the government’s failure to control black market activity. It is the consumer--not the pharmaceutical industry--that ultimately pays the price. The illegal profits of the black market are built into the price of filling every single prescription.

“The losers are grandpa and grandma who are going to the corner drugstore to get their prescriptions filled,” said Keith McDonald, chief investigator for the Nevada Pharmacy Board.

Moreover, experts say the safety of prescription drugs is being compromised when pharmaceutical products--both regular medications and controlled substances--pass through the hands of black marketeers who disguise the origin of the drugs in an effort to escape the scrutiny of state and federal regulators.

There is no guarantee that wholesalers operating outside the law have properly stored sensitive drugs and no way of tracking these black market drugs in the event of a manufacturer’s recall.

“It brings into question the viability of the whole health care record-keeping system,” said Jim Dahl, the FDA’s special agent in charge of investigations. “When you have wholesalers buying product without regard to pedigree, it also gives rise to counterfeiting.”

The Clinton Administration’s health care reform plan, sent to Congress earlier this year, contained a provision that would have eliminated the prescription drug black market by altering the pricing of wholesale pharmaceuticals. But the proposal died with the legislation.

To be sure, there are many law-abiding wholesalers operating in the drug industry. Yet even some legitimate, full-line drug wholesalers are said to be guilty of complicity in the black market by purchasing prescription drugs from known black marketeers.

Two California firms, McKesson Corp. in San Francisco and Bergen Brunswig Corp. of Orange, the nation’s largest drug wholesalers, have been named by the government as participants--but never charged--in several criminal cases involving black marketeering of prescription drugs over the past decade. Executives of both firms deny any wrongdoing.

Likewise, some major pharmaceutical manufacturers, who are being defrauded by the black market practitioners, do little to discourage the activity because the illegal sales add to their bottom lines.

In their zeal to increase market share, some drug company salesmen have been known to overlook signs of black market activity--such as a buyer claiming to supply drugs to nursing homes who orders large quantities of acne cream, menopause medicine or other drugs not intended for use by the elderly.

Pharmaceutical industry analysts contend that drug companies inadvertently invited criminals into their business by creating a multitiered pricing policy frequently assailed by critics.

The pricing system works this way: While pharmaceutical companies offer deep discounts on drugs purchased by hospitals, nursing homes and other institutions, they give no price breaks to wholesalers who supply retail pharmacies. The theory behind institutional discounts is that they encourage product loyalty among physicians and patients.

In some cases, the regular wholesale price can be many times the price paid by institutions. For example, Ciba-Geigy Corp. sells transderm-nitro patches for heart attack patients for $8.40 to institutional pharmacies, like those operating in nursing homes, and $39.89 to the retail druggist--a difference of 375%.

Because the price disparity is so wide, the system offers big profits to middlemen who have devised schemes that enable them to buy the drugs at low prices and divert them into the regular retail market.

In industry parlance, this activity is known as “drug diversion” and the people who do it are called “diverters.”

The opportunity for attractive profits is obvious to anyone with the barest grasp of the pharmaceutical industry and the basic rules of commerce.

“You learn about this in Economics 101,” said Los Angeles lawyer David Katz, who represents longtime drug diverter Wilbur Swift. “If you decided to sell milk to girls at 60% of the price charged to boys, what would happen? You’d have girls standing in line buying boys milk.”

Most drug diverters began as legitimate wholesalers, retailers or pharmacists and gradually moved into the black market trade in order to boost profits or save themselves from failing in a business where the profit margins are very narrow.

Predictably, however, the promise of big profits has attracted some elements of organized crime to drug wholesaling. In 1992, Kansas City underworld boss Anthony (Tony Ripe) Civilla was convicted along with Rubin for wire fraud in connection with such a scheme.

“Holding up a bank doesn’t make sense when you can get into this business,” said Nevada’s McDonald.

To law enforcement officials on the West Coast, the names of Martin Rubin, Robert Fenton, Wilbur Swift, and Robert and Ben Lax are synonymous with black market prescription drugs. They say they are typical of the people involved in this business, many of whom operate in Southern California and Nevada.

Until they quarreled in 1989, Rubin and Swift were partners in a prescription drug operation with business addresses in Van Nuys and Las Vegas.

The pair went into business with financial help from the Lax brothers, whom Rubin identified in court as experienced diverters. Rubin and Swift also worked closely with Fenton in Nevada. In court documents, Rubin described Fenton as “a friend of mine and associate that has been in the business a long time.”

When their business was at its peak, according to court records, Rubin and Swift each earned about $200,000 a year by acting as middlemen between the small diverters--the institutional pharmacies--and big wholesalers such as McKesson. They estimated their yearly profits at 30% to 40%.

Even before enactment of the Prescription Drug Marketing Act, the two were well aware that their business was predicated on fraud. Yet whenever they approached potential suppliers, they insisted that they were doing nothing illegal.

According to trial testimony, Rubin and Swift sometimes tried to skirt the legal issue by advising potential suppliers not to agree to a so-called “own use” clause in their contracts with manufacturers. (In such a clause, a buyer, usually an institutional pharmacy, certifies that the drugs are for its own use and not for resale.)

But they knew their suppliers would be forced to agree to an own-use contract in order to buy cut-rate drugs.

When Swift testified at Rubin’s trial in Kansas City, he was asked by the prosecutor: “When you told them to avoid signing own-use clauses, was that essentially to cover yourself?” He replied: “Basically, yes.”

“All of these people that I dealt with knew it was illegal,” Rubin added. “They had the own-use clause. They knew.”

After the Prescription Drug Marketing Act was enacted, Rubin and Swift still refused to acknowledge they were violating the law. Rubin admitted on the witness stand that he dismissed the measure as unimportant, and soon found what he considered to be loopholes in the law.

Timothy I. Kristol, an attorney whose client was interested in purchasing a company in Rubin’s network, said in court documents that he was told by lawyers representing the firm that diversion was only “a technical violation” of the law that would never be prosecuted as long as it was not flagrant.

But law enforcement officials came after them nonetheless: Rubin and Swift were convicted for wire fraud in Arizona in 1989, and Rubin was again found guilty in 1991 in a similar case in Kansas City.

Neither Rubin nor Swift would agree to an interview.

Since their conviction, Swift says he has retired from the business and Rubin contends he restricts his activity to acting as an adviser to other wholesalers, according to their attorneys. Nevertheless, their legacy lives on.

Swift sold his company, Drug World, to a Chicago lawyer who later purchased a wholesale operation in Las Vegas that state authorities say was previously involved in diversion.

Likewise, Rubin sold his business to people who have been frequently identified by law enforcement officials as diverters. According to internal federal investigation documents obtained by The Times, this company in 1993 was still serving as a supplier of diverted pharmaceuticals.

As for Fenton, according to reliable law enforcement sources, he continues to do business in Nevada, Washington state and Oregon under intense scrutiny from FDA investigators. The Lax brothers are said to have retired from the business. None of the three has been charged.

McKesson, Bergen Brunswig and other major drug wholesalers acknowledge that they sometimes purchase cut-rate drugs from smaller businesses, some of whom may have been linked in the past to black market activity. In industry parlance, this is known as “second-source buying,” “alternative-source buying” or “investment buying.”

But the major wholesalers contend they never knowingly purchase any drugs obtained illegally. Milan A. Sawdei, Bergen Brunswig’s chief legal officer, noted that his company very carefully screens alternative-source suppliers and requires them to sign a contract swearing that none of the drugs they are supplying to the firm were obtained by fraud.

“Bergen has a policy that we only acquire first-quality goods that are legal,” Sawdei said in an interview. “It’s a serious process. Somebody doesn’t just call and say: ‘I want to be a Bergen supplier.’ We have turned down many people. In fact, we just terminated a supplier because his paperwork was not in order.”

But Sawdei acknowledged that he cannot say for certain that none of Bergen Brunswig’s merchandise was ever obtained illegally. “I strain to say never,” he said.

Industry experts say black market goods are a substantial part of the secondary-source market, simply because it is seldom possible to resell drugs purchased at low-rate prices without defrauding the manufacturers.

Eric Gordon, Rubin’s attorney, explained that diverted drugs are often funneled through a number of wholesale companies--in some cases, interlocking companies with the same ownership--in order to “clean up the pedigree.”

Bergen Brunswig was named as recipient of diverted drugs by several defendants who pleaded guilty as the result of a two-year FBI investigation of drug wholesaling centered in Atlanta in the mid-1980s. According to a plea agreement filed in federal court in December, 1985, Roger Allen Johnson, a defendant, purchased diverted drugs while employed as a buyer for the firm.

Nevertheless, Sawdei emphasized, “Bergen Brunswig has never been named as a target or source of any investigation” dealing with black market drugs.

Likewise, although both Rubin and Swift have testified that they regularly sold diverted drugs to McKesson, Tom Walsh, vice president and general manager of McKesson Trading Co., the wholesaler’s second-source buying arm, said his company has since implemented reforms to prevent buying from diverters.

“We feel comfortable that the people we’re buying from are not the caliber of Rubin or Swift,” Walsh said.

Walsh said most of McKesson’s non-manufacturing suppliers specialize in buying drugs in advance of a manufacturer’s price increase--not from institutional pharmacies.

McKesson, with $11 billion in annual revenue, buys only about $300,000 a year from secondary sources, according to Walsh. But because the wholesaler operates on a slim profit margin, he acknowledged that buying drugs below the standard manufacturers’ price is “very important to the bottom line.” Wholesalers say the pharmaceutical manufacturers seldom question these activities.

Since enactment of the Prescription Drug Marketing Act, only a few drug companies--such as Wyeth-Erst, Schering-Plough and Lederle Laboratories--have adopted aggressive programs to detect violators of the own-use clause.

Pharmaceutical company executives say it is difficult to enforce the own-use clause in court because, as one official put it, “we make lousy victims.” Jurors are unsympathetic to the drug companies, which are often faulted by consumers for high prices and big profits.

The government’s first serious effort to prosecute anyone for drug diversion under the Prescription Drug Marketing Act will begin playing out Monday, when Jerry W. Holden, a former protege of Swift’s, goes on trial in U.S. District Court in Mississippi on charges that his tiny institutional pharmacy was illegally diverting drugs to a wholesaler on Long Island, N.Y.

The FDA’s failure to enforce the law against diverters before now has been disappointing to Dingell, who in 1988 portrayed enactment of the legislation as a breakthrough. “Drug diversion is rampant because the Prescription Drug Marketing Act is not being enforced,” Dingell said.

From the day the law was enacted by Reagan, it was clear that the government’s top policy-makers had little interest in enforcing it. Reagan himself said when he signed the bill that he had “grave doubts” about it and added: “The magnitude of the public health problem created by diverted drugs is still not clear.”

Nor was there any sense of urgency at the FDA. Charma Konner, director of the FDA’s division of drug quality evaluation, said she cannot explain why her agency still has not finalized regulations that were issued on a preliminary basis in 1990 to implement the Prescription Drug Marketing Act.

“Some of these things do take a while,” Konner said.

To date, the FDA’s enforcement of the law has focused almost entirely on preventing the sale and adulteration of drug samples. Not until March, 1992, did the FDA create an office of criminal investigation to look into such cases.

Prosecutors are said to shy away from drug-diversion cases because they are complex and the penalties are often light. As McDonald put it: “The juice isn’t worth the squeeze.”

Furthermore, defense attorneys representing diverters argue that the law is flawed. Thomas Spina, Holden’s attorney, will challenge the government’s case on grounds that while the law specifically outlaws drug diversion by what it calls “health care entities,” Holden’s business was not a “health care entity” because it never provided any direct patient care.

“Unless you bought it from a health care entity, it’s not illegal,” insisted David L. Miller, vice president of JAM Distributors, a small wholesaler in Orange that dabbles in the secondary drug market. The Prescription Drug Marketing Act “does not prohibit this type of conduct.”

Law enforcement officials said many nursing home pharmacies escape the definition of a “health care entity” by transferring the low-priced drugs to separate corporations before reselling them. If Holden is convicted, however, these officials said it will put them in a stronger legal posture to go after black market activity in the future.

The FDA’s Dahl insists that his agency is on the verge of bringing several big drug-diversion cases. “We’re going to make an impact on the illegitimate industry,” Dahl said. “Even a few prosecutions will have an impact.”

While stepped-up FDA enforcement might chase some diverters out of the marketplace, as Dahl believes, most experts agree that an easier way to shut down the black market would be to abolish the multitiered pricing system.

If manufacturers sold drugs at one price, according to Kenneth Sain, chief investigator for California’s State Board of Pharmacy, “they could be selling it for more and the public would be getting it for less.”

When President Clinton unveiled his ill-fated health care reform bill earlier this year, his proposal to eliminate multitiered pricing sent shock waves through an industry that has long defended the system.

Rubin learned of the President’s plan while he was incarcerated in the federal prison at Lompoc. He promptly sat down and wrote a letter to Clinton offering to serve as an adviser to the Administration on the drug pricing issue.

Rubin was disappointed that the President did not respond.