Drug giant Pfizer Inc. says it will appeal a court ruling in Pakistan that has called its behaviour “oppressive” and sided with a small group of investors who had alleged that the multinational systematically drained the coffers of its local operations through artificially high prices for drug ingredients.
The eight investors—two others died waiting for the verdict—are part of a dwindling group of shareholders who now own less than 0.5% in Pfizer Laboratories Ltd (PLL), which is the current version of Pfizer’s operations in Pakistan that has origins in a manufacturing facility opened in 1961. Some of the shareholders who have been fighting Pfizer in court maintain that their original holdings are investments that their parents made in a company called Dumex, acquired by Pfizer in 1959.
At its core, the legal battle is fairly simple. The shareholders allege that Pfizer has deliberately contributed to poor results at its Pakistan operations, thus continuously diluting the value of the minority stakeholders’ shares in an attempt to get 100% control of the business for a lot less than what it is worth.
Interwoven into this saga is a larger issue of “transfer pricing,” a common system under which related but separate companies assign prices for goods or services transferred from one company to the other. Because these are negotiated prices, there can be a potential for one company, especially the parent or majority shareholder, to take advantage of a unit.
Governments and regulators in the developing world, including India and Pakistan, have been particularly wary of opaque transfer pricing mechanisms as they fear that a foreign parent company could use such transactions to drain resources away from the local unit to a foreign parent. That is precisely what happened with PLL, say these minority shareholders who allege that Pfizer sold raw materials at huge markups. They say because Pfizer took equity in return for the cash it pumped into the struggling operation, the drug giant ended up with a growing share of PLL at the cost of minority investors whose equity only fell over time.
According to a court ordered examination of PLL’s practices done by Ernst & Young, Pfizer exported drug raw materials to the Pakistani unit at prices that were, in some cases, up to 70 times those charged by alternative providers. For example, the court papers show, amlodepine besylate, the active ingredient in high-blood pressure medicine Norvasc, was sold at $30,000 per kg while alternative sources could have provided it for as little as $500 per kg. Another example was of piroxicam, used in arthritis drug Feldene, which was allegedly imported by PLL at $8,750 per kg, compared with $125 per kg in the market. Another ingredient, doxycycline, found in antibiotic Vibramycin, was imported by PLL at $700 per kg though it could have been purchased for $60 per kg.
There is no independent way for Mint to ascertain additional details of the imports, including whether other suppliers could have provided the same raw materials at the prices cited.
Pfizer did not return repeated calls nor did it respond to detailed questions that were sent by email to its New York headquarters. A. Majeed, director and company secretary for Pfizer in Pakistan, declined to answer questions.
In an email, Majeed wrote: “The issues raised in your questions are all subject matter in a court case thereby making the issues subjudice and therefore, we cannot provide any comment at this stage.” Asked if an appeal was planned, Majeed simply wrote “yes.”
But a judge in Karachi agreed with the minority investors, citing Pfizer’s treatment of them as “oppressive.” The ruling of the Sindh high court also ordered an independent auditor to calculate a new valuation of PLL’s shares, taking into consideration the “artificial losses” created by Pfizer’s “transfer pricing.”
The decision comes at a time when Pfizer, the world’s largest drug company by sales, is reporting weak earnings—its second-quarter earnings fell 48%, and emerging markets in Asia and Eastern Europe are increasingly becoming more important for growth. Meanwhile, Pfizer also faces a much more high-profile legal battle in another emerging market—Nigeria—where the government is planning a lawsuit seeking at least $7 billion in damages from Pfizer for what it alleges were illegal drug trials on children there. Pfizer has denied any wrongdoing.
Back in Pakistan, the minority shareholders insist that even if their battle is about much smaller amounts, it is a matter of principle.
“When you’re young and starting out, you invest something for your old age and your kids,” Mohammed Ali Khan said of his paediatrician father’s motivations in buying 100,000 shares in the late 1950s. He recalls his parents meeting Pfizer board members in New York, then later entertaining company executives in their Karachi home in the 1950s and 1960s.
For the next three decades, some of the shareholders, including Khan, note that PLL was largely profitable, declaring dividends and bonus shares on a regular basis. By 1990, it reported profits of Pakistani Rs160 million, with equity amounting to Rs98 per share. But, in 1991, the company embarked on a change in business strategy, which one of the shareholders describes as the beginning of the downturn.
But investors were still hopeful about the company’s prospects. In 1995, chartered accountant Azfar Hasnain bought 126,242 shares in PLL for his son Zahid, then in college, at about Rs12.50 per share. Back then, about 23% of the company was held by minority shareholders, with the rest owned by Pfizer, he said.
For the next few years, PLL’s sales still grew steadily, at an average of 4% per year. But, because of the huge markup on drug ingredients—offset by money pumped in from the parent and taken back in the form of shares—the Pakistan unit began operating at a loss and shareholder equity shrank.
Throughout the 1990s, these shareholders say, their questions about Pfizer’s practices were brushed off at multiple annual meetings. Matters came to a head in 2000 when Pfizer prevailed in acquiring Warner-Lambert Co. for $90 billion in stock and the two companies agreed to merge subsidiaries worldwide.
In Pakistan, PLL was to be merged into Parke Davis & Co. Ltd, a unit of Warner-Lambert, through a share swap ratio of 264 PLL shares to one Parke Davis share, creating a company called Pfizer Pakistan that could eventually be traded on exchanges in the country.
The per-share swap value of PLL was derived based on a 2001 audit by accounting firm KPMG. At least 10 minority shareholders objected to the merger, claiming that a Rs10 share of PLL (in Pakistani rupees) had been reduced to just four paise. The remaining 20 or so minority shareholders—some scattered around the world—did not pursue legal action.
“I am surprised at how a large company can get away with it,” said Nurallah Merchant, who inherited 50,000 shares, along with his wife. “I am an actuary by profession so I understand these things. I was requested by my father-in-law to get involved.”
But the investors suffered a setback when, in 2002, the court denied their request to stop the merger of PLL and Parke Davis. But, in doing so, the court also ordered Pfizer to buy them out at a “reasonable” price. Along with that ruling, the court also ordered a second valuation of PLL, this time from auditor Ernst & Young.
It is that report—completed in 2003—which now forms the basis for the latest ruling, which was issued on 21 May and details of which have only recently come to light.
“It may be argued that the financial position of PLL is a direct consequence of the decision of its management to operate in the manner described,” the report said, citing the inflated drug prices. “…such management decisions have been in the interest of the majority shareholder, which is also its principal supplier of raw materials.”
By 2002, the E&Y report concluded, PLL’s losses amounted to more than Rs930 million—equal to more than 152% of the total value of the company.
The court concurred that the impact of transfer pricing on both the profitability of PLL and the valuation of minority shares was not adequately taken into consideration at the time of the proposed merger.
Says Mohammad Ali Sayeed, who served as the lead lawyer for the minority shareholders in the case: “Indeed, it is the first judegment of its kind considering transfer pricing as an instrument of oppression of the minority shareholders. This practice has been guarded against in the income-tax law of Pakistan.”
Sayeed is also hoping that this judgment would spur the Securities and Exchange Commission of Pakistan to initiate an investigation into the affairs of PLL. All we want is “a fair price for the shares,” says sha-reholder Zahid Hasnain in a phone interview from Karachi.
The years have taken their toll. In addition to two of the original parties to the lawsuit dying, today, only 0.35% of PLL is held by minority shareholders. And for Pfizer, the merger of PLL and Parke Davis is pending the resolution of the valuation of minority shares, notes Azfar Hasnain, who has a power of attorney for PLL shares held by his son who is largely overseas.
Because Pfizer was unwilling to respond to specific queries, Mint was unable to ascertain how its business is currently performing in Pakistan or get responses to some of the shareholder assertions. The companies are running in an “efficient manner,” according to Pfizer’s website.
“A similar investment made in other company would be 40 to 50 times more,” says Khan, who holds the 100,000 shares with his brother, Abbas. “That’s the reason I am fighting for this thing. It’s a personal principle.”