A Bonus for Bankruptcy? - KV Pharmaceutical Reveals CEO's Bonus, then Declares Bankruptcy

The latest example of the disconnect between compensation for leaders of health care organizations and their and their organizations' performance comes from a <a href="http://www.bizjournals.com/stlouis/news/2012/07/26/kv-pharmaceutical-ceo-divis-pay-more.html">report</a> in the St Louis Business Journal.  <br /><br /><strong>Executive Compensation and KV Pharmaceutical</strong><br /><br />Its essence was:<br /><blockquote><em>KV Pharmaceutical Co. President and CEO Gregory Divis Jr. earned <strong>$976,270</strong> in the fiscal year<strong> ended March 31</strong></em>, more than double the $385,102 he was paid in fiscal 2011, according to a proxy statement the company filed Thursday with the Securities and Exchange Commission.<br /><br /><em>His 2012 earnings were comprised of a $638,750 salary, a <strong>$130,000 bonus, $204,189 in option awards</strong> and $3,331 in other compensation</em>, which includes a $2,909 car allowance, a 401(k) match and group term life insurance.<br /><br />The total pay for other top executives was as follows:<br /><br />Treasurer and Chief Financial Officer Thomas McHugh earned $506,615 in fiscal 2012, including a $65,000 bonus. Hit total comp in fiscal 2011 was $320,950.<br />Vice President, General Counsel and Secretary Patrick Christmas earned $530,604 in fiscal 2012. He joined the company in June 2011.</blockquote><br />Admittedly, compensation of just under $1 million a year does not seem that high for the CEO of a pharmaceutical company in this day and age. Furthermore, as <a href="http://www.forbes.com/sites/edsilverman/2012/07/30/kv-pharma-ceo-gets-hefty-raise-despite-all-the-problems">noted</a> in Forbes, Mr Divis' compensation is less than that of his predecessor:<br /><blockquote>who was interim ceo and president, received $1.25 million before Divis succeeded him, and so the ceo is now being compensated at a lower amount. </blockquote><br /><strong>The Troubled History of the Company</strong><br /><br />However, first consider that the company was not exactly in the best financial health at the time Mr Divis was getting his pay, as per the St Louis Business Journal:<br /><blockquote>KV Pharmaceutical Co. officials said July 20 that the company has been <em>notified by the New York Stock Exchange that it is below listing standard criteria</em> due to the company’s average market capitalization being less than $50 million over a 30-day trading period and its stockholder’s equity being less than $50 million.<br /><br /><em>After years of missteps, mismanagement and mounting losses, KV Pharmaceutical’s ability to survive is in question</em>. <em>The company itself raised doubts as to its ability to continue as a going concern in its quarterly filing<strong> Feb. 9</strong></em> with the Securities and Exchange Commission. [Note that this filing occurred during the same fiscal year in which the CEO received the compensation noted above - Ed.]</blockquote><br />In fact, as we discussed <a href="http://hcrenewal.blogspot.com/2010/11/former-kv-pharmaceutical-ceo-and.html">here</a> in 2010, a former KV Pharmaceutical CEO and Chairman is one of the very few for-profit health care corporate leaders who actually received personal punishment due to a US government prosecution. Former CEO and Chairman Marc Harmelin was banned from doing business with the US government for 20 years after a fraud prosecution that lead to "a KV subsidiary's conviction on criminal charges earlier this year for shipping oversize morphine tablets" <a href="http://www.stltoday.com/business/kv-s-hermelin-is-banned-from-federal-health-care-programs/article_f51abe32-a767-5f3b-bf55-4978db665cab.html">per</a> the St Louis Post-Dispatch.<br /><br /><strong>The Failed Strategy to Get a License for a Previously Generic Drug, and Increase its Price by Ten Thousand Percent (10,000%)</strong><br /><br />Then consider the direction company leadership took after that setback.  As described in an August, 2012, St Louis Post-Dispatch <a href="http://www.stltoday.com/business/local/kv-pharmaceutical-files-for-bankruptcy/article_4a26c62c-dfde-11e1-9ffb-0019bb30f31a.html">article</a>, the company's main strategy was based on a license to sell Makena, an injectable form of hydroxyprogesterone. Hydroxyprogesterone had first been approved in the 1950s. In 2003, a National Institute of Health funded study showed that injecting it reduced the risk of premature birth [Meis PJ, Klebanoff M, Thom E et al. Prevention of recurrent preterm delivery by 17 alpha-hydroxyprogesterone caproate. N Engl J Med 2003; 348: 2379. Link <a href="http://www.nejm.org/doi/pdf/10.1056/nejmoa035140">here</a>.]. Somehow, with funding from KV Pharmaceutical, "the FDA granted the approval to Hologic, which presented the application and argued for the drug based on medical research sponsored by the National Institutes of Health." After that, while "KV neither invented nor patented Makena, but agreed to pay Hologic nearly $200 million for 'orphan drug' status – and seven years of market exclusivity – for the rights to sell the branded drug." I cannot figure out why either company should have been granted an exclusive right to sell this drug under these circumstances. Nonetheless, once KV Pharmaceutical obtained the rights, <br /><blockquote>Makena sparked a national controversy over <em>its sky-high price – a 100-fold increase over the average cost – about $15</em> – <em>for an already widely available non-branded version</em> of the drug produced by compounding pharmacies.<br /><br />Leading national medical organizations and advocacy groups, including the March of Dimes and two U.S. senators, publicly blasted the pricing.<br /><br />On March 30, 2011, the FDA announced that it would not enforce KV’s market exclusivity because of concerns that the drug would be unaffordable to many women. Hours later, the federal Centers for Medicare and Medicaid Services indicated that states could purchase the compounded version, called 17P, from specialty pharmacies.<br /><br />The resistance prompted KV executives to dramatically lower Makena’s cost, but the move failed to forestall the backlash. As a result, KV’s ambitious sales projections for its latest drug failed to materialize.</blockquote><br /><strong>Bankruptcy</strong><br /><br />That sealed the company's fate, and the same article reported,<br /><blockquote>KV Pharmaceutical Co., once among the St. Louis region’s strongest public companies, now faces yet another survival struggle after filing for bankruptcy.</blockquote><br /><strong>Summary: A Bonus for Bankruptcy</strong><br /><br />So a company that suffered a criminal conviction for selling morphine tables whose dose was twice what was on their label, whose former CEO was banned from the pharmaceutical industry, which based its survival on a scheme to game the regulations to allow it to sell a previous $15 drug for $1500, then paid its CEO nearly $1 million, including over $330,000 in cash bonus and stock options just before it filed for bankruptcy.  Note that the CEO "earned" that compensation over a time period during which the company revealed doubts that it could survive as a "going concern."<br /><br />This is a simple, relatively small, but especially graphic example of how leaders of health care organizations are not simply overpaid, but seem to personally profit from their organizations' mismanagement, poor financial results, and last but not least, exploitation of patients. Describing these incentives as perverse seems euphemistic.<br /><br />Economists seem to like to justify outsized executive compensation by citing shareholder value they create, realistically defined as short-term stock price (look <a href="http://hcrenewal.blogspot.com/2012/04/health-care-dysfunction-explained-by.html">here</a>).  One could argue that companies that sell health care products or provide health care directly should measure performance in terms of effects on patients' and the public's health.  Putting this aside, however, in this case, the executives seemed to be receiving bonuses not based on shareholder value, or stock price, but for continuing a course that resulted in the complete destruction of shareholder value.  (Stock shares lose essentially all their value when a company goes bankrupt.)  <br /><br />In this case, and in others we have <a href="http://hcrenewal.blogspot.com/search/label/executive%20compensation">discussed</a>, executive compensation seems to be based on the ability of executives to control their own pay, which seems more like what economists like to call "rent-seeking," as <a href="http://en.wikipedia.org/wiki/Rent-seeking">defined</a> by Wikipedia, gaining from "manipulating the social or political environment in which economic activities occur, rather than by creating new wealth."  <br /><br />Clearly, as long as health care leaders can personally profit however bad their performance is, or even due to their poor performance, we can expect nothing other than worsening performance.  Health care will become continually more dysfunctional until true reform makes health care leaders accountable for their actions, and all their effects, on stockholders, but also on patients' and the public's health.

A Bonus for Bankruptcy? - KV Pharmaceutical Reveals CEO's Bonus, then Declares Bankruptcy

The latest example of the disconnect between compensation for leaders of health care organizations and their and their organizations' performance comes from a report in the St Louis Business Journal. …

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Former KV Pharmaceutical CEO and Chairman Banned from Government Business

Early this year we <a href="http://hcrenewal.blogspot.com/2010/03/sacks-medical-kv-pharmaceutical-plead.html">noted</a> that a subsidiary of KV Pharmaceutical, Ethex, pleaded guilty to two felony counts, and paid a fine in response to charges "stemming from its failure to make and submit to the U.S. Food and Drug Administration a report on its discovery of undistributed pills that 'failed to meet product specifications,' ...."   At the time, we noted that this was yet another marcher in the parade of <a href="http://hcrenewal.blogspot.com/search/label/legal%20settlements">legal settlements </a>affecting health care organizations.  In this case, as in many others, despite the acknowledgement that unethical actions, worse, crimes were committed, no person appeared to suffer any penalty or negative incentive.  As usual, we argued that settlements like this would be perceived by unscrupulous leaders as mere costs of doing business, and would not deter future bad behavior.<br /><br />That was then, and this is now.  Bloomberg just<a href="http://www.bloomberg.com/news/2010-11-17/kv-pharmaceutical-s-hermelin-resigns-after-u-s-ban-will-sell-stake.html"> reported</a>:<br /><blockquote>KV Pharmaceutical Co. said <em>Marc Hermelin resigned as a director and will sell his controlling interest after being <strong>banned from doing business with the U.S. government</strong> for two decades</em>. KV rose in New York trading.<br /><br />Hermelin left the board on Nov. 10 and will sell his shares, said Catherine Biffignani, vice president of investor relations, in a telephone interview today. Hermelin, 68, had been fired as chairman and chief executive officer of Bridgeton, Missouri-based KV in December 2008. He held about a 52 percent voting stake, either in his own name or through trusts, according to a company filing on May 7. KV didn’t specify the timing of the stock sales.<br /><br />The ban takes effect tomorrow.</blockquote><br />This was really news. As the article noted:<br /><blockquote>Hermelin will become the <em>first drug-company owner or executive barred from doing business with the government</em> in an antifraud push involving Medicare, the insurance program for seniors and the disabled, and Medicaid, the health program for the poor, according to the Health and Human Services Office of Inspector General’s website.</blockquote><br />We just <a href="http://hcrenewal.blogspot.com/2010/11/this-is-really-going-to-set-peoples.html">discussed</a> an indictment of a former GlaxoSmithKline executive. Now we have a KV Pharmaceutical executive banned from doing business with the government. So all of a sudden, it looks like the US government has realized that when health care organizations violate the law, their executives do not have complete impunity.<br /><br />Of course, things immediately became more complicated. The St Louis Post-Dispatch just <a href="http://www.stltoday.com/business/article_95b38ed5-a19d-57b3-9e78-9b1afa70be24.html">reported</a>:<br /><blockquote>In yet another major shakeup, KV Pharmaceutical's board chairman, a member of its audit committee and its chief financial officer quit this week.<br /><br />The chairman and audit committee member <em>charged that KV's newly elected board can't provide the independent oversight</em> the company needs. The new board had been elected last Thursday.<br /><br />The CFO, John Stamp, quit on Monday and has not been replaced, the company said in a regulatory filing released Wednesday afternoon.<br /><br />KV also revealed that the new board had terminated interim CEO David A. Van Vliet. The company last week announced that Van Vliet had been replaced but gave no details.</blockquote><br />What seems to be going on here is resistance to the continued control of the company by the family of the now banned former CEO:<br /><blockquote>In their resignation letters, board chairman Terry Hatfield and audit committee member John Sampson said they had 'serious concerns regarding the ability of the newly constituted board and senior management to provide the required independent oversight of KVs business during this critical time in the company's history.'<br /><br />They noted that only three of the board's seven nominees for board seats were elected at KV's annual meeting last Thursday. The remaining elected members were candidates proposed by shareholders.<br /><br /><em>The family of the firm's founder, Victor Hermelin, retains 52 percent of the Class B shares, which have super voting rights</em>, according to the company proxy issued in May.<br /><br />Among those re-elected to the board was Marc Hermelin, son of the founder, who was ousted as CEO in 2008. Also re-elected was <em>David Hermelin, the son of Marc Hermelin and a former director of corporate strategy who retained his seat on the board.</em><br /><br />David Hermelin was among the board's nominees. Marc Hermelin was not.</blockquote><br />As soon as the government appears to get somewhat serious about imposing negative consequences for bad behavior in health care, one can expect that the leaders of organizations who have personally profited from bad behavior in the past will try to come up with work-arounds.<br /><br />Nonetheless, it may be that if health care leaders realize they do not have complete impunity, and they may be held responsible for the bad behavior of the organizations they lead, they may behave better. One can hope.<br /><br />One can also hope that increasing evidence about the bad behavior of leaders of health care organizations will lead to increased unwillingness by health care professionals to go along with, or at least ignore such bad behavior that compromises their own professional values.

Former KV Pharmaceutical CEO and Chairman Banned from Government Business

Early this year we noted that a subsidiary of KV Pharmaceutical, Ethex, pleaded guilty to two felony counts, and paid a fine in response to charges "stemming from its failure to make and submit to the…

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