The Third Circuit’s decision in In re Avandia Marketing, Sales Practices & Product Liability Litigation, No. 14-1948 (3d Cir. Oct. 26, 2015), accepts a path-breaking fraud-on-the-intermediary theory under the Racketeer Influenced and Corrupt Organizations Act of 1970 (RICO), which allows you to recover three times your actual damages plus reasonable attorneys’ fees. Expect more cases like this.

Diabetes drug

GlaxoSmithKline LLC (GSK) started selling Avandia, a treatment for Type II diabetes, the most common type, in 1999. GSK touted the drug as better and safer than the options then on the market. But buyers of Avandia paid at least twice what the alternatives cost.

The seeming merits of GSK’s new offering prompted third-party payors (TPPs) to add Avandia to their “formularies”. As the Third Circuit explained:

The formularies are prepared by analyzing research regarding a drug’s cost and effectiveness, safety and efficacy. When a [pharmacy benefit manager] determines that a drug offers advantages over a competing drug, it will give that drug preferred status on the formulary. A TPP will typically cover more of the cost of a particular drug when that drug has a higher preference status on the formulary. The greater coverage of cost by the TPP allows the member to pay a lower co-payment when prescribed the drug.

In re Avandia, slip op. at 6.

Over the years, Avandia produced billions of dollars in sales for GSK.

Trouble in drugland

In 2007, The New England Journal of Medicine published a study that found Avandia raised the risk of  heart attack by 43 percent. (More than two-thirds of diabetics die of heart attack or stroke.) GSK responded with a marketing campaign to discredit and drown out the study. The Food and Drug Administration (FDA) allowed GSK to keep selling Avandia but mandated more warnings on packaging.

On February 20, 2009, Allied Services Division Welfare Fund, a TPP in Illinois, filed a class action case alleging that GSK violated Pennsylvania’s and other states’ consumer protection laws. Another followed in May 2010.

On September 23, 2010, after the U.S. Senate issued a damning report, the FDA sharply limited the patients doctors could prescribe Avandia to.

On October 13, 2010, a third TPP, United Benefit Fund, brought a RICO action. It alleged that a RICO “enterprise” included “co-promoter” Bristol-Myers Squibb and fraudulently promoted use of Avandia through a pattern of racketeering activity consisting of wire and mail fraud and other crimes.

Ruling for plaintiffs

The district court denied GSK’s motion to dismiss on standing grounds. It ruled that the plaintiffs had alleged enough of a “concrete injury” from GSK’s conduct. But the court also certified its decision for appeal.

The Third Circuit affirmed. It contrasted a case in which the plaintiffs alleged that a health maintenance organization made untrue promises about the quality of the healthcare services it would provide its members in the future. The case before the court differed because:

[T]he injury suffered by the TPPs here is not contingent on future events. The TPPs’ damages do not depend on the effectiveness of the Avandia that they purchased, but rather on the inflationary effect that GSK’s allegedly fraudulent behavior had on the price of Avandia.”

Id. at 17 (emphasis in original).

The panel also rejected GSK’s point that doctors and patients made the causal link between GSK’s conduct and the TPPs’ injury too remote. It said:

GSK does not argue that a doctor’s decision to prescribe Avandia or a patient’s decision to take Avandia caused plaintiffs’ injuries. The conduct that allegedly caused plaintiffs’ injuries is the same conduct forming the basis of the RICO scheme alleged in the complaint – the misrepresentation of the heart-related risks of taking Avandia that caused TPPs and PBMs to place Avandia in the formulary.

*  *  *  *

The amount of damages is either the difference between what Avandia coverage cost and the cost of coverage of cheaper, safer drugs and/or the overvaluation of Avandia caused by GSK’s misrepresentations. This issue of damages, rather than demonstrating a lack of proximate causation, raises an issue of proof regarding the overall number of prescriptions (under the “quantity effect” theory) or amount of price inflation (under the “excess price” theory) attributable to GSK’s actions.

Id. at 26-27.

Fraud-on-the-intermediary theory

The outcome in Avandia validates a damages approach that could prove potent. The methodology posits that a defendant’s fraudulent promotion of goods or services causes harm by inflating both (1) the cost of each resulting purchase transaction and (2) the number of transactions. The fact that the fraud works against intermediaries (the TPPs) makes the theory more plausible, not less. The TPPs’ main job consists of getting prices that reflect value and avoiding purchases that do no good.

It looks like a variation on the fraud-on-the-market theme to me. As in securities cases, the scheme pumps up the price the drug maker can charge all buyers. It also tricks TPPs into vouching for the drug, prompting more prescriptions, higher usage, and greater sales.

The Avandia plaintiffs still have a way to go. They must fend off multiple attacks, including the claim that the TPPs would not have acted differently if they had known the whole truth about Avandia’s risks. But I admire their ability to persuade the court of appeals to credit the link between an effort to inflate price and sales and a damages methodology that focuses on the improper degree of inflation — a fraud-on-the-intermediary approach.