U.S. Prescription Drug System Under Attack Multibillion-Dollar Shadow Market Is Growing Stronger

By Gilbert M. Gaul and Mary Pat Flaherty
Washington Post Staff Writers

For half a century Americans could boast of the world's safest, mostly tightly regulated system for distributing prescription drugs. But now that system is undercut by a growing illegal trade in pharmaceuticals, fed by criminal profiteers, unscrupulous wholesalers, rogue Internet sites and foreign pharmacies.

In the past few years, these illegal operators have siphoned off growing numbers of popular and lifesaving drugs and diverted them into a multibillion-dollar shadow market. They have introduced counterfeit pharmaceuticals into the mainstream drug chain. And they have hawked millions of doses of narcotics over the Internet.

The result too often is pharmaceutical roulette for millions of unsuspecting Americans. Cancer patients receive watered-down drugs. Teenagers overdose on narcotics ordered online. AIDS clinics get fake HIV medicines.

Normally, drugs follow a simple route. Manufacturers sell them to one of the Big Three national wholesalers -- Cardinal Health Inc., McKesson Corp. and AmerisourceBergen -- which sell to drugstores, hospitals or doctors offices. Regulators and industry officials have long considered this straightforward chain to be the gold standard.

The illegal operators exploit gaps in state and federal regulations to corrupt this system, creating a wide-open drug bazaar that endangers public health. A yearlong investigation by The Washington Post has found:

• Networks of middlemen, felons and other opportunists operating out of storefronts and garages fraudulently obtain deeply discounted medicines intended for nursing homes and hospices. The medicines are stored in U-Hauls and car trunks in blazing heat, manhandled, stuffed in plastic sandwich bags and traded in a daisy chain of transactions with no purpose except to enrich the traders. Those drugs are ultimately sold to unwitting patients.

• Counterfeiters using pill-punching machines and special inks produce near-perfect copies of the most popular and expensive drugs. They pass undetected through wholesalers to the shelves of retail pharmacies.

• Pharmaceutical peddlers take advantage of lax regulations to move millions of prescription drugs into the United States from Canada, Mexico and elsewhere. Overwhelmed customs workers inspect less than 1 percent of an estimated 2 million packages containing medicine shipped into the country each year. Virtually all of those shipments are illegal, yet the Food and Drug Administration fails to enforce its own import regulations, saying it lacks the resources to intercept the illegal packages.

• Rogue medical merchants set up Internet pharmacies that serve as pipelines for narcotics, selling to drug abusers and other buyers who never see doctors or undergo tests. The sellers move tens of millions of doses of hydrocodone, Xanax, Valium, Ritalin, OxyContin and other controlled substances. Scores of customers have become addicted, overdosed or died.

These illegal pharmaceutical sales have rapidly multiplied, with little public attention.

Isolated problems nationwide have attracted the interest of some state and federal prosecutors and resulted in lawsuits. But the increasing recalls of tainted medicines, overdoses on Internet-bought drugs and cross-border pharmaceutical trade are part of a larger pattern. Taken together, they constitute a new form of organized crime: a shadow market in prescription drugs that now threatens the public.

In St. Charles, Mo., Maxine Blount, a 61-year-old woman with advanced breast cancer, received a diluted drug distributed to her local drugstore. "It makes you angry," she said in an interview last year. "It shakes your faith. It saps strength you need to live." She died a month later.

In San Diego, Ryan T. Haight, 18, died in his bedroom of an overdose after taking narcotics obtained on the Internet.

In Sacramento, James Lewis, 47, shopped the world for painkillers that flowed unimpeded from pharmacies in South Africa, Thailand and Spain. His wife discovered him dead of an overdose on the living room couch.

These victims are emblematic of the dangers to public heath that occur when profiteering and cowboy criminality invade the nation's drug distribution system.

The shadow market takes advantage of technology, global trade, vast disparities in pharmaceutical prices, the explosive growth of enticing new miracle drugs and the self-medicating habits of an aging baby-boom population. It extends from small backroom operations to buck-raking Internet pharmacies to the warehouses of the nation's largest drug distributors.

Small-time operators reap millions illegally by buying drugs at a discount to sell to secondary wholesalers, which then sell them to other distributors, including the Big Three wholesalers that supply most major hospitals and chain stores. The Big Three risk buying from these secondary sources because they can get drugs more cheaply than if they bought them directly from manufacturers. But sometimes those drugs are diverted, diluted or counterfeited.

William K. Hubbard, senior associate FDA commissioner, stressed that the U.S. drug distribution system is the safest in the world. "People can have a high degree of confidence," he said in an interview.

Yet he acknowledged that in recent months the FDA has been overwhelmed by illegal imports from Canada and off-shore pharmacies. The agency also had to apologize to Congress in June for releasing a quarantined shipment of fake Viagra to consumers. And the FDA is now scrambling to keep up with a rise in drug counterfeiting.

Phony medicines have surfaced in pharmacies from Florida to Hawaii, including tens of thousands of doses discovered in warehouses of the Big Three wholesalers. In July, nearly 200,000 tablets of Lipitor, the world's best-selling cholesterol-lowering medication, was found to be counterfeit and recalled. Some of the pills had already reached Rite Aid and CVS pharmacies.

"This is hurting people," said Thomas E. Getz, a federal prosecutor in Cleveland who has pursued pharmaceutical fraud. "It's one thing to ask people to choose between name brand or generic," he said. It's another to "choose a bottle that came from a manufacturer or one that's been sitting in a hot semi for three weeks."

In the past year, a Texas wholesaler bought cancer drugs that had been spirited out in backpacks and, at least once, in a fast-food bag, from Methodist Hospital and the University of Texas M.D. Anderson Cancer Center in Houston. A drugstore in Scotch Plains, N.J., sold insulin and brand-name drugs stolen from Beth Israel Deaconess Medical Center in Boston. Pharmacies and wholesalers from Miami to Los Angeles sold medicines that Medicaid fraud rings bought off the streets.

Americans are spending more money than ever on prescription drugs. Between 1994 and 2001, the number of prescriptions swelled to 3.1 billion -- a nearly 50 percent increase. In nearly the same period, sales soared from $61 billion to $155 billion.

There were several reason for this. Americans took advantage of new and better medicines, including a range of preventive drugs. Insurers promoted the use of prescription drugs to keep down the number of more expensive hospital stays. Employers picked up a large share of drug costs. And advertising by drug manufacturers drove demand, especially for lifestyle drugs such as Viagra and Celebrex.

"Americans want their Lipitor," said David B. Nash, a physician who directs the Office of Health Policy and Clinical Outcomes at Thomas Jefferson University in Philadelphia. "They want to be able to take it on their way to McDonald's."

The Drug 'Diverters'

At the center of the shadow market are drug "diverters" -- armies of little-known brokers who illegally gain control of discounted medicines intended for nursing homes, hospices and AIDS clinics. Those drugs are only supposed to be sold to small pharmacies that serve those facilities and have no retail business. In return for favorable prices from drug manufacturers -- as much as 80 percent off -- the pharmacies must enter into contracts pledging not to resell those drugs on the open market. For that reason, they are also known as "closed-door pharmacies."

But criminals often hide behind those closed doors.

An examination of numerous court filings shows that drug diverters from Florida to North Dakota to California have set up hundreds of institutional pharmacies, buying billions of dollars worth of prescriptions drugs. In some cases, the diverters get their own licenses in states where regulation is lax. In other instances, they use straw men to front for them. In still others, the diverters bribe owners of closed-door pharmacies to order drugs for them.

Often, fraudulent closed-door pharmacies consist of little more than a desk, a fax machine and a few shelves. Yet they place excessively large orders with drug manufacturers.

Anthony Rizzo, who owns a small drugstore in Jamestown, N.Y., obtained millions of dollars in discounted drugs by claiming to serve nursing homes with 4,100 beds. In fact, he served none, court records show. "In an ideal world, the volume of his orders should have raised red flags, but everyone was too happy to be making a buck," said John E. Rogowski, who prosecuted Rizzo.

The diverters take the discounted drugs, mark up the prices and rapidly move them to small wholesalers who add another markup and sell to other wholesalers. In some cases, pharmaceuticals may change hands six or more times, going from state to state.

No one knows how big the drug diversion market is. State and federal investigators say losses easily amount to billions of dollars annually.

If Jesse James were alive, "he wouldn't make his money robbing banks," said Terrell Vermillion, who oversees criminal investigations for the FDA. "He would have a cell phone, fax and mail drop and be an illicit-drug diverter."

One of the masters is Marty Rubin, a hulking 53-year-old with a penchant for Las Vegas gambling tables. Rubin moved from Brooklyn to California with hopes of pitching in the major leagues. When that did not happen, he became a stock boy in a drugstore and found the business "he loved," his lawyer later said.

His real business was fraud. Three times since 1989, Rubin has been caught diverting medications. Federal cases in Phoenix, Kansas City, Mo., and Los Angeles depict Rubin as the man behind pharmacies and wholesaling operations throughout the West and Southwest that illegally moved $12 million worth of drugs.

He has repeatedly apologized to judges and promised not to divert again. Each time, he has broken his promise. Rubin, who declined requests for an interview, is serving a federal sentence in South Carolina.

As drugs are diverted, the integrity of the country's drug distribution chain is imperiled, said Louis Ling, general counsel to the Nevada State Board of Pharmacy. Diversion, he said, has "gone from being an embarrassing nuisance to a dangerous piracy."

Many Licenses, Few Inspectors

Existing laws and regulations present few barriers to entry into the wholesale drug market.

It can be harder to become licensed as a beautician than as a pharmaceutical distributor. With a $700 permit fee and a $200 bond, a pair of Florida manicurists got a license to sell wholesale intravenous drugs. An auto body shop owner in Miami got a license to sell wholesale drugs in Maryland. Nevada awarded a license to a 23-year-old former restaurant hostess to operate an Internet pharmacy that specialized in narcotics.

"The problem is, just about anybody can get a license: 50 states, 50 sets of rules, 50 places to venue shop," said Joe Riley, an FBI agent in Newark who has investigated pharmaceuticals stolen in cargo heists. "And that's the first thing that's thrown back once they're caught with stolen goods or counterfeit drugs: 'Hey, the guy I bought from faxed me a copy of his license.' " Florida gave licenses to at least nine felons, records show. Two states -- Georgia and Tennessee -- gave a wholesaler license to James R. Suozzo of Fort Lauderdale, Fla., a convicted cocaine user with an eighth-grade education and a 27-year history of heroin abuse, records show. Suozzo's background surfaced when he was arrested in February on suspicion of attempting to sell adulterated Procrit, Epogen and Neupogen to another small wholesaler.

Nationwide, there are an estimated 6,500 small wholesalers, yet most states have only a handful of inspectors. In some states, amusement park rides, elevators and even dog kennels are inspected more frequently than drug wholesalers.

Virginia has nine inspectors for 684 wholesalers, and Maryland has seven for 632.

Maryland permits wholesalers to operate from private homes, which explains how Ultra Medical Inc. is licensed at a buff-colored split-level with maroon shutters on High Tor Hill Drive, a cul-de-sac in Columbia. The company Web site advertises products for cancer, HIV and plasma.

Pauline Clarke answered the door recently and said she ships and receives pharmaceuticals for Ultra Medical, whose president lives in Atlanta.

I try not to keep the refrigerated stuff more than 24 hours," said Clarke, who declined to allow a reporter inside.

Company president Sony Roy said in an phone interview from Atlanta that Ultra Medical has only "two or three customers who buy from time to time." The Web site is out of date, Roy said, and the company "is dwindling."

Federal investigators cannot compensate for their outmanned state counterparts. The FDA has 170 criminal investigators who must stretch to cover cases involving everything from spoiled food to herbal medicine to complicated drugs.

In 1988, Congress attempted to stop diverters by passing the Prescription Drug Marketing Act. The law required that wholesalers provide a piece of paper -- similar to a car title -- disclosing all prior sales. The paper trail, known as a pedigree, would allow each wholesaler to verify they were buying from reputable sources.

But wholesalers objected to what they deemed to be burdensome paperwork and said the new law would drive some smaller wholesalers that serve niche markets out of business.

On four occasions, those protests caused the FDA to back off from implementing the rule, leaving it in limbo for 15 years.

"It is not surprising, then, that some pharmaceutical wholesalers have fought so hard and long to keep the federal rule in abeyance," a Florida grand jury concluded earlier this year. "In essence, the wholesale industry is fighting for the right to keep secret from their own customers the history of the drugs that they're being sold."

When some states crack down, the problem shifts elsewhere.

In the late 1990s, Nevada required wholesalers to have pharmaceutical experience and pass a test. Lawmakers also limited the amount of product a wholesaler could sell to another wholesaler, to allow for better tracking. Several operators relinquished their licenses and no new ones have applied. Nevada's number of licensed wholesalers plummeted from about 50 in 2002 to eight this year.

But they merely moved across the state line, said Judi Nurse, supervising inspector for the California Board of Pharmacy.

"We have more of them now than ever," Nurse said. "I'm scrambling just to try to keep up."

The Big Three Drug Wholesalers

Three Fortune 500 companies -- Cardinal Health Inc. of Dublin, Ohio; McKesson Corp. of San Francisco; and AmerisourceBergen of Chesterbrook, Pa. -- dominate the drug wholesaling industry, with combined annual revenue of $146 billion. They are known in the business as the Big Three.

The wholesale drug industry is characterized by high volumes and a razor-thin profit margin of about 1 percent of revenue. If the large wholesalers can purchase drugs for less than the manufacturer's price, the spread goes straight to their bottom line. That explains why the giants sometimes are willing to turn to much smaller secondary wholesalers for cheap drugs -- although the big companies say they do not knowingly buy from diverters.

But lawsuits and drug recalls show that such deals have exposed the Big Three to counterfeit and diverted medications.

Since 2000, the large wholesalers have had to recall thousands of bottles of counterfeit product. On occasion, the giants have sued small wholesalers, alleging that they were the source of the bad drugs.

In 2000, AmerisourceBergen bought 52 bottles of counterfeit Retrovir, an HIV medication, from a small Ohio wholesaler, Florida health inspectors said. The bottles were found during a routine inspection in 2001 at AmerisourceBergen's Orlando distribution center. By turning to the smaller wholesaler rather than buying directly from the drug's manufacturer, AmerisourceBergen saved about $8 per bottle on a product that costs nearly $300 a bottle, sales records show.

The company paid a $50,000 fine in the Orlando case, which also included purchases from other wholesalers not licensed in Florida. In a letter to Florida authorities, the company said that it "regrets that alleged counterfeit Retrovir was received and distributed." The letter also said that "due to the volume of product received daily," the wholesaling giant "is not able to inspect each piece of product that is received."

In a separate incident two years ago, a lawyer for Bergen Brunswig, which has since merged with Amerisource, invoked the crush of business in a case that developed after Florida regulators cited the company for dealing with unlicensed wholesalers. If the company had to independently verify a supplier's license for each of the hundreds of orders it handles daily, "the time and cost involved would be considerable," the lawyer wrote, adding that the company "is ill-equipped to engage in such policing and monitoring activities."

In a response, Sandra Stovall, an attorney for the Florida Department of Health, wrote that the company's practice "appears to present an environment" conducive to counterfeiters.

For what Florida called "a pervasive disregard" of the rules, Bergen paid a $1,500 fine.

In 1999, federal prosecutors in Las Vegas targeted Amerisource as part of a broad investigation of illegal drug diversion in the Southwest. Working with Fred Evans, a two-time felon, the FBI set up an undercover business known as V.N. Chicago Inc. in a Las Vegas shopping mall. In seven months, V.N. bought $31.2 million worth of deeply discounted drugs meant for hospices and nursing homes from the Sacramento division of Amerisource. V.N. quickly diverted the drugs to other smaller wholesalers, earning nearly $1 million in profit.

The FBI in Las Vegas shut down its investigation in February 2000 without charging Amerisource or the other wholesalers. As far as Amerisource was concerned, the case was over.

It lay dormant for two years until FDA and FBI agents in California took over the file. In July, the U.S. attorney in Sacramento charged Robert Strusz, a sales manager at Amerisource's distribution center there, with mail fraud. He pleaded guilty in August and is cooperating with investigators.

Strusz had worked closely with Evans to arrange the sale of the discounted drugs to V.N. Chicago. According to court documents, Strusz saw his bonus boosted by the sales and he also received kickbacks. Strusz declined to comment. A spokesman for Amerisource said the diversion scheme stopped at Strusz.

Before he left Amerisource, Strusz taped conversations with several company managers, according to law enforcement officials familiar with the investigation. The investigators are now reviewing those tapes to determine whether other Amerisource officials were involved.

'Golden Boy' Gets Caught

In the mid-1990s, David Dyck was known as the "golden boy" around Bindley Western Industries Inc.'s drug distribution center in San Dimas, Calif., federal investigators said. Personable and charming, Dyck brought in millions in sales and played a large role in making San Dimas one of the huge wholesaler's most profitable hubs.

Dyck's job included recruiting business from the hundreds of closed-door pharmacies in the Southern California-Las Vegas corridor. He took his job an extra, illegal step, introducing those pharmacies to diverters.

Dyck was paid handsomely, court records show. He received approximately $500,000, which he funneled through a shell company he set up in his daughter's name, Santa Susanna Consultants Inc.

He was caught by a federal investigation. In 1999, he pleaded guilty to mail fraud and began to cooperate. Nearly 18 months later, Bindley pleaded guilty to conspiracy in federal court in Nevada and agreed to pay a record $20 million fine.

The San Dimas case was not the first time Bindley's name surfaced in drug diversion. In 1989, the company pleaded guilty to mail fraud involving its Atlanta distribution center and paid a $500,000 fine. Four Bindley managers, including a top executive at headquarters in Indianapolis, also pleaded guilty.

Bindley did not respond to a request for an interview. However, in a 2000 news release, company officials said they were "shocked" to learn of Dyck's crimes.

Dyck, who now works for another California health care company, recently said in an interview, "Believe me, I didn't do anything without the knowledge of superiors. Do you think Bindley paid $20 million because I did something wrong?"

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