Last year was a good one in China for pharmaceutical giant GlaxoSmithKline, as well as an obscure Shanghai-based travel agency. The profits of the travel agency, Linjiang International Travel Agency, increased exponentially: we’re talking millions of yuan to hundreds of millions (1 yuan = R1.60). GlaxoSmithKline, meanwhile, increased its business in China by an impressive 17%, raking in revenues of around $1.5-billion.

This year it was not so good.

In a highly unusual public briefing on Monday, the chief of China’s corporate corruption watchdog (yes, it exists, and it’s got teeth too) accused GSK of using the travel agency – and three others like it – as a front for a massive and deliberate corruption campaign to increase its share of the lucrative Chinese market.

According to economic crimes unit boss Gao Feng, it was a pretty sophisticated operation. The travel agency would invoice GSK for travel arrangements that didn’t happen, or charge for 50-person conferences when only 30 were invited (police say they busted Linjiang, and through it the whole operation, because GSK was its only client, and they didn’t seem to offer much in the way of travel services). After taking their cut of this extra cash, the travel agencies would return it to GSK executives, giving them a slush fund. This was mainly used to bribe doctors into stocking and prescribing GSK drugs – some doctors were given special credit cards, into which funds would be transferred the day after a major drug purchase.

One more detail: to keep the GSK executives sweet, for this was a very profitable arrangement for them, the travel agents would throw in the odd sexual favour.

Gao’s verdict on GSK was damning: “We found that bribery is a core part of the activities of the company. To boost their share prices and sales, the company performed illegal actions.” He said police were examining $488-million worth of potentially corrupt transactions, and have already arrested four GSK executives.

By any standards, this is a lot of money – but then the pharmaceutical market in China is worth a lot more. It’s already the third largest in the world, and is expected to be worth around $370-billion by 2020, as China’s increased spending on drugs and private healthcare takes off. The stakes are high.

GSK have, tellingly, not denied the allegations explicitly. Instead, they’re trying to shift the blame onto their local staff. “We are deeply concerned and disappointed by these serious allegations of fraudulent behaviour and ethical misconduct by certain individuals at the company and third-party agencies. Such behaviour would be a clear breach of GSK’s systems, governance procedures, values and standards. GSK has zero tolerance for any behaviour of this nature.”

This explanation is hard to buy. There has not yet been any suggestion – sexual favours aside – that the GSK executives implicated were doing this for personal gain. This was corporate corruption, for corporate profit, and however you look at it, GSK’s top brass are guilty of either knowing about the bribes, and informally sanctioning them; or failing to exercise proper oversight of their staff in a major market known for corruption issues. Ignorance is no excuse.

But even more disturbing has been the reaction of the global financial markets, which have barely batted an eyelid. GSK is trading on the London Stock Exchange at 1,735.50 pence, a .52% drop from Monday. Bloomberg’s article on the story is dominated by comment from analysts explaining that the news and any potential fines are unlikely to be of particular concern to either the company or its investors. “While being involved in criminal offenses and associated with illegal actions is clearly damaging for GSK’s reputation, I doubt that this will be of material impact for the company,” said one analyst, Fabian Wenner, a Swiss-based health care expert. “I haven’t spoken to any investor who is concerned about this yet.”

That’s because investors aren’t all that worried about the adverse impact of corruption on China’s health system, focusing instead on the bottom line, which is unlikely to be unduly affected. The penalty for corruption on this scale doesn’t really match the crime. Bloomberg cites estimates, based on previous corruption cases in China, of fines worth around $5 – to $10-million. This is hardly a disincentive to corruption when the bribes allegedly paid by GSK fuelled the company’s rapid growth in China (they can afford plenty more fines with their $1.5-billion China business).

But investors should be worried. The GSK case is part of a larger government effort to force down the price of pharmaceutical products as it tries to expand better-quality healthcare to rural areas. Investigators have already hinted that other pharmaceutical companies are under investigation. And, even more significantly, the government launched an inquiry earlier this month into why drugs in China are so expensive – often more expensive than their equivalents in other developing countries. A similar inquiry into manufacturers of baby milk resulted in an almost immediate 20% price drop.

GlaxoSmithKline know, however, that with their range of niche products and their extensive patent protection they won’t be forced out completely – and will continue to make money in China, no matter what. From now on, though, they’ll have to watch themselves.

“I need to remind foreign pharmaceutical companies that because they occupy a leading position in the industry and reap huge amounts of commercial profits, they should also bear a great responsibility to society and the public,” said Gao. “While we don’t expect them to set a moral example, we expect them to obey the law.” DM

Read more:

Sexual Favors Spur Glaxo’s $1.5 Billion China Sales, Police Say on Bloomberg

GSK is test case in China’s rules laboratory on Financial Times

Photo: A Chinese national flag flutters in front of a GlaxoSmithKline (GSK) office building in Shanghai July 12, 2013. GlaxoSmithKline executives in China have confessed to bribery and tax violations, the country’s security ministry said on Thursday, during one of a string of investigations into foreign firms in the world’s second-biggest economy. GSK said in a statement that it took all allegations of bribery and corruption seriously. “We continuously monitor our businesses to ensure they meet our strict compliance procedures – we have done this in China and found no evidence of bribery or corruption of doctors or government officials,” it added, saying it would cooperate with the authorities. REUTERS/Aly Song