so heretofore in this course we have treated government as one
of two things: either,
as in de Soto’s frame of reference,
a guarantor of property rights; or as just background material,
as with Smith, where the gravamen of Wealth
of Nations and the invisible hand story is to encourage
governments to allow free markets and free trade.
There’s not much talk about
governments and how they behave. And today I wanted to correct
that deficiency a little by talking about government,
and in particular, about the government of the
United States. Then turning to the Vioxx,
the Merck-Vioxx case, and looking at a little bit of
video of Mark Lanier who is the main trial lawyer litigant
nationally in the Merck matter. Now the United States is a very
unusual political system. It is a so-called presidential
system often copied. There are probably–I haven’t
counted them, there are probably twenty,
perhaps twenty-five countries with regimes that look on the
surface like the American one, and they have in common that
almost every one of them has failed.
Almost every one of them is
wildly unstable. The organic growth of the very
complex American Constitutional order is essentially unique,
and it begins with what I think of as the genius of the founding
fathers expressed particularly in Federalist 10 and Federalist
51, where the object is to create a
complex system; system which makes it hard for
people to put together winning coalitions in favor of new
policies; which gives enormous advantage
to those defending existing policies;
which, by the scale and complexity of so large a system,
and they thought, when they began,
of the thirteen colonies as a huge republic,
and it was a huge republic. What came after is the largest
complex republic the world has known, and probably it is as
large as is feasible with a republican form of government.
The combination of
federalism–so there are two major layers of government,
and the expected diversity of so large a country make it hard
to form majority coalitions. Even when you form majority
coalitions, the system of checks and
balances in the Constitution, augmented by the later
emergence of the committee system in the House and Senate
at the federal level, make putting together a winning
majority very difficult. Arguably the last presidential
and congressional elections created a winning coalition for
some form of healthcare reform. Though one would have to admit
that listening to the election wasn’t much specificity about
what that might be. If you watch what’s happened
since, the powerful resistance to change which is built into
the system has manifested itself.
Now from the point of view of
capitalism, it is generally supposed that this is a plus.
That the stability of economic
policy and the endurance of laws relating to property patents,
commerce, that the relative stability of all that owes
something to the fact that no mere short-lived majority can
transform the American political system and its policies.
I think that’s broadly true.
The only contingency in which
one would fear for the American republic,
and there are people–New York Times columnist Frank
Rich, for example,
New York Times columnist David Brooks for another
example, who fear that we’ve come to
that difficult position, and that position is this:
if the existing status quo is unsustainable,
as one might have thought the status quo on the regulation of
banking and mortgages was six months or a year ago,
and as some argue the healthcare system is now,
then all the checks and balances which make change
difficult may make it impossible to escape from that very
difficult status quo. Now I am personally an optimist
about the ingenuity and resilience of the American and
political and economic order, but it’s important right now to
begin what we’re doing today, understanding that changing
public policy is a heroic undertaking.
The change of public policy,
which will be in the background in the Vioxx case,
is tort reform. Part–which plays a huge role
in the Vioxx case, tort law does,
and is in the background as a major factor in the healthcare
reform story because the risk to medical practitioners from
surgeons to nurses that is presented by tort law is very
great and we’ll try to cover some of that using Vioxx as our
case. When Vioxx was in the testing
stage I went to my internist and tried to talk him into getting
me into the trial because I was still playing tennis then,
and Vioxx allowed me to–Vioxx seemed like a miracle drug.
The merit of it,
a Cox-2 inhibitor, was that it seemed to reduce
inflammation in your joints and therefore reduced pain without
creating inflammation and erosion in the intestine.
Aspirin and other similar drugs
reduce inflammation in the joints, but, as a byproduct,
tear at the intestine. He was wise enough to say,
“You know, not every innovation is what it
appears to be, and I would urge you not to be
in the trials.” Being a compliant fellow I took
his advice, and in retrospect, I guess I’m glad.
The American system,
and this is not part of the original design,
has built up an enormous practice in lobbying and high
powered lawyering at the federal level,
and K Street is to lobbying what Wall Street is to finance.
The existence of trade
associations for every imaginable thing is a leading
factor in American politics, and whomsoever would seek to
control or create some new efficiency or new form of
justice in public policy has to fight her or his way through K
Street. The–I’m about to give you a
series of generalizations which are broadly true,
each admits of exceptions, but they are about what are the
advantages if we want to play the K Street game?
One is concentrated interests,
where a particular class of individuals or companies have a
lot at stake, is a huge advantage.
Why is it a huge advantage?
Because it will provoke them to
spend money on lobbying and influence, and they will have
the money. Whereas, as disbursed
interests, where there are perhaps tens of thousands or
even millions of people who have small stake in an outcome will
not readily form a well financed interest association,
and will therefore be less strong than a concentrated set
of interests which form a well financed coalition.
It goes with the second point
as a truism. Well-financed causes trump
poorly financed ones. There are exceptions to that
but not a lot. Remember that it is a market
society, and money talks. It is a market society in which
the first amendment gives money rights;
that is, if I want to spend money putting forth a point of
view and you want to regulate my right to do that,
my first recourse of defense for the right will be to go to
the courts and say that you’re infringing my right of self
expression. And the courts have often,
not unambiguously, but often, ruled in favor of
that view. Defending the status quo is a
hell of lot easier then changing it.
The legislative process is full
of veto points. The commonest result for
legislation introduced in the House of Representatives is that
it is assigned to a committee and nothing else happens.
It’s assigned to a committee
and nobody brings it to the floor for a vote.
The committee may not even hold
hearings. If the chair of the committee
is hostile to it, he probably–hostile to it and
he thinks it might have support, he will refuse to hold hearings
in a way that’s not really the subject of this course,
the succession of ways in which you can kill new legislation is
spectacular. Another issue,
the one about agency–agency capture is a big advantage.
By this we mean that if you are
in the airline business, let us say, and there is a
Civil Aeronautics Bureau, which is assigned the task of
regulating your industry, if your industry can make an
alliance with that agency itself,
can capture the agency, that can be worth an enormous
economic sum because it will allow you to structure public
policy in a way which suits the combined interests of your
industry. Something of the same is said
to be at play, and almost certainly is at
play, in the relationship between the pharmaceutical
interest and the FDA. I’ve just said that and that at
the same time. The CAB, Civil Aeronautics
Bureau, ruled the airline industry from its inception
until the late 1970s. In the late 1970s it was
repealed. The regime it created assigned
routes to particular companies, so you would apply to the
government for the right to fly from LaGuardia in Chicago to–
LaGuardia, New York to Midway in Chicago,
or from Midway in Chicago to LAX.
The agency would assign routes
to make sure that there was not undue price competition.
It would protect oligarchical
pricing, and that is to say highly profitable pricing.
It would work the Porter
Forces, if you will, to the advantage of the
incumbent airlines. New entrants could be frozen
out, price competition was minimal,
most of the competition had to do with amenities,
most famously with airline attendants averaging twenty-five
years of age, and all women and none married.
The air travel business was
restricted and wildly inefficient.
What killed this arrangement
was the observation made by some law and economics people that
the airlines which were not subject to it,
and the only airlines that weren’t subject to this
regulation were ones which flew entirely in one state,
and the most famous case was the flight between the San
Francisco/Oakland area and the LA/San Diego area,
where fares were low, they were less than half
comparable fares on interstate flights.
A similar story in Texas from
Love Field, Dallas in a hub pattern around
the state of Texas, fares were lower,
safety was just as good, service wasn’t quite as good,
but there was genuine price competition.
This group came to the fore and
created a national coalition to deregulate the airlines.
The effect was well let’s take
somebody at random. Who’s had–how many of you look
forward to air travel? Somebody want to give us a
thirty second essay on why it’s hard to–why it’s not a lot of
fun to travel by air? I’ll save us time.
It’s because flights are by and
large full and the Transportation Safety
Administration provides an initial indignity on each trip,
and because service is totally minimal.
You have to buy your own graham
crackers for lunch. It’s not–unless you fly first
class or business class, which Yale does not allow
except for the very highest ranking officers at the
university right now, and then only on very long
flights. Air travel isn’t fun at all,
but what it is is efficient and it is in real terms vastly
cheaper than it was under the regulatory regime.
And I bring it up just to point
out the advantage of regulation under the old CAB regime from
the point of view of the airlines and not from the point
of view of the passengers. The effect of deregulation was
a long series of bankruptcies in which the legacy carriers went
broke. Those which have survived,
they had gotten so fat under the old regime,
that they were wildly inefficient.
And most of them died off and
those which survived had to go through convulsive change to get
their operating costs low enough to compete with the new wave
carriers such as Southwest or JetBlue.
Well the FDA is,
from a strategic point of view, broadly analogous to the CAB.
The FDA is a huge regulatory
jungle which creates powerful obstacles to new entrants,
and which requires drug companies to be extremely well
financed in order to get new products through the mill.
The impact of that has been to
create a relatively small number of gigantic pharmaceutical
companies, many of them very well run,
and to induce those pharmaceutical companies to aim
at blockbuster drugs. Merck is one of those companies.
It’s–I’ve shown you this
diagram about combining know-how with capital and motivation to
get something done. In a highly regulated
environment you’ve also got to worry about the regulatory and
legal apparatus in a big way, and these companies are really
good at that. They have adapted to the regime
of the Food and Drug Administration,
and are terrifically good at that, and they are able to put
up pretty high barriers to competition from new entrants.
The typical outcome for
somebody–for a small firm which has a drug candidate,
is that they get to a certain stage in the preliminary phases
of testing and then sell or license the drug to one of the
major pharmaceuticals. I’ll post this slide.
It’s the history of Merck’s
interaction with government and government’s road toward the
FDA. The interesting thing,
it’s in the case about Merck, is that it’s property was
seized during World War I, and for the American government
to seize the property of a corporation is a very rare
event, but the problem was of course
World War I, the Germans were the bad guys.
They ended up having to buy
their property back on loans from Wall Street.
The reason they got the loans
is that Merck was a great company, a great company with
centuries of history. The two legislative acts which
are perhaps important to the background of this case are the
Prescription Drug User Fee Act of 1992 and the FDA
Modernization Act of 1997, both of which gave–put the
drug companies in the position of funding the FDA’s
investigation of their proposals.
Now in looking for a
blockbuster drug, think of the green square as a
space representing all the possible diseases that drugs
could fix. They range on the vertical
scale from acute at the bottom to chronic on the top,
from rare on the bottom to common on the right.
I said chronic up here,
or I meant chronic up here. It is obvious to you where the
money is to be made in the pharmaceuticals business?
Yes back left.
Student: Common and
chronic. Prof: Pardon.
Student: Common and
chronic. Prof: Common and
chronic, because if acute, the customer may not stay alive
long enough to be truly profitable,
and common is–has its obvious benefit.
The idea of a Cox-2 inhibitor,
the business plan behind the Cox-2 inhibitor was to advertise
the hell out of it and to capture a huge generation of
people forty and older with bad knees,
tennis elbow, all those stiff necks,
all those things which go on for decades,
during the seventeen year patent to make billions upon
billions of dollars. Blockbuster drugs,
in fact, do make billions upon billions of dollars,
and there is a market failure problem with this model,
which has to do with less common and more acute diseases.
Many, many small disease
populations get disproportionately small
investment in drug research because of the logic of
blockbuster drugs. Merck has had two really famous
CEOs in recent time. This is Roy–I’ve had both
these guys in my classroom to teach this case at one time or
another, Roy Vagelos was a–is an M.D., and a brilliant M.D.
and an idealist.
He at one point–I don’t know
if this–is river blindness drug in this case?
Yeah, the river blindness drug
is one where he– the government wouldn’t pay to
distribute the drug in Africa, but he just had Merck pay,
and thinks he got his money back in the motivation of his
research staff. Ray Gilmartin,
who succeeded him, and comes in for great abuse in
the Mark Lanier video we’ll look at,
Ray Gilmartin is an MBA, worse yet a Harvard MBA,
and was hell for leather marketer.
He looked at the Cox-2
inhibitor market as the best single market available in the
generation to Merck and put a huge sales force out there,
and went full stop, and sometimes a little over the
line, with the ethics of inducing
doctors to prescribe the drug. Sometimes by straightforward
favor giving, sometimes by invitation to
so-called research conferences, which were in actual fact
golfing holidays of the kind– now what’s wrong with a golfing
holiday aimed at M.D.’s, if we remember Sharon Oster?
Do we remember?
Student: If I remember
correctly, she said it was that if the
doctor was willing to go on golfing holiday,
that means the opportunity cost he’s losing is not that high,
so it’s probably not a doctor that sees a lot.
so the doctors with the lowest opportunity costs were going to
Hawaii, go to Hawaii,
and they’re not the people you’re trying to reach.
That’s certainly true of the
heart technology, maybe a little less true of
Vioxx, where a very low key practice where you just casually
advise people to take this drug would be very valuable.
The common law tradition,
the English common law is derived not from legislation but
from cases, and builds up through precedent
where each new case is analyzed by its analogy or lack thereof
to earlier cases which raised the same legal issues.
This tradition goes back a
thousand years, or nearly a thousand years,
and came to the United States with the immigrants who came to
New England in the seventeenth century and is a dominant part
of the American Legal Code, which is largely separable from
Congress and the Legislative process.
And central to it is the idea
that courts should make the victims of careless,
reckless, or fraudulent products whole;
should make them–should bring them back to a situation as good
as they would have been in if they had not received the bad
product. Beyond that,
often punitive damages, where if we say this person was
harmed to the extent of $100,000 so we’d pay him the $100,000 at
the expense of the company. We then say,
this is a huge company, $100,000 means nothing to this
company so let’s say $100 million.
Most of the $100 million is
punitive damage, which nonetheless goes to the
victim, but is meant to teach the company a lesson.
Well from the point of view of
business, punitive damages are very scary.
And the American legal
landscape is a particularly complex one for that reason
because with federalism, Ghen v.
Rich, you remember it,
Ghen v. Rich is about tort law,
and about setting incentives in a way that works well for
society as a whole, and the problem with Merck
Vioxx is similarly that. I’ll give you one more common
law case to get the feel of this.
At the close of World War II,
the guy who owned this property near an airport sued the airport
for the noise of planes going through his airspace.
He said I own the airspace;
they can only come through if they have my permission or pay
me rent on the use of my airspace.
The plaintiff had a very strong
common law precedent. The common law theory of
airspace was that you make a projection from the–
after people were sure the world was round,
it’s a spherical projection, to the ends of the universe,
you owned everything that is in that spherical projection over
your land. Now you were–you’re a judge,
its 1947, the airline industry is just getting strong,
and you’re presented with this case.
Tal, how would you decide it?
since the airline industry is just getting strong I might want
to incentivize them to keep flying and keep
>which would obviously be very
difficult if I let every single person–
it would obviously be very difficult to let the airline
industry form if I let every single person who owns property
control the airspace over their property because then they would
have to– the transaction costs would be
huge to negotiate with each and every single person.
That nails the question.
A flight–a little flight from
Chicago to Milwaukee or from Milwaukee to Madison,
Wisconsin or from Madison, Wisconsin to Minneapolis,
would involve thousands of transactions and license fees
with the owners of all the land you’re going to traverse,
and the airline industry would be stillborn for that reason.
In the background of this case,
just as in the background of Ghen v.
Rich, is creating
incentives for those who are prepared to invest in the
generation of value and ultimately of wealth for the
society as a whole. Mr. Justice Douglas,
in May of 1946, wrote the opinion in U.S.
Cosby, which decided the
case in favor of the airlines and against the landowners.
Now the plaintiff bar–let’s
not do the summaries. Let’s see if I can remember how
we’re going to do this. DVD stage, play,
this is a set of interviews we sent a–
this is Mark Lanier: “I think Merck ultimately
has to settle, maybe not all of the cases,
but Merck certainly needs to settle the good cases.
What Merck needs to do is wait
until the statute of limitations runs.
What that means is that there’s
a time period after you’re damaged where you have to file
your lawsuit, and if you don’t file within
that time period your rights are gone.
Merck needs to go ahead and
wait and let that time period run,
so that there is a fixed denominator,
how many cases are out there, and then the numerator,
how many of those is Merck going to settle,
can be determined. I’m not sure that Merck needs
to settle every case out there. These cases are expensive to
fight and they’re hard to fight, and so Merck can satisfactorily
settle the difficult cases of serious injury,
where really I think all of us ultimately agree Merck owes the
money, and then Merck can take those
cases of lesser liability and ultimately tell the lawyers,
‘You want us, come get us.’ That’s where this has got to
end up I think.” I think there are probably
about 25,000 to 30,000 cases that ultimately will be filed
against Merck. Out of those 25,000 to 30,000
how many of them are good cases? I would guess probably–you’ve
got different degradations of good.
It’s like students,
there’s A good and there’s B good, then there’s C not so
good, and then there’s D and F, really not good at all.
How many A/B cases in that
grouping? Over half of them I think are
probably A/B cases. How many of those are C’s?
Maybe a third;
how many of them are D and F? Maybe about 25%,
I don’t know, my percentages may not add up,
but it’s something in those ranges at least.”
My guess is $12 to $15 billion
dollars for liability for Merck. I think if Ken Frazier,
the general counsel for Merck, came to me and said,
‘Lanier here’s $12.5 billion dollars,
make my headache go away,’ I could come pretty close to
resolving all of his issues.”
“There’s a great deal of
difficulty in trying to set up a jurisdiction for hearing these
cases. The way the law is set up,
philosophically the plaintiff who has a burden of proof,
the plaintiff has to prove their case,
and a tie goes to the defendant if you will.
The plaintiff with a burden of
proof is supposed to get a pick of forum.
By that it means if you’ve got
to prove your case you should be allowed to choose in which court
you want to do it. Realistically,
in America, all of our courts are supposed to be fair,
but practically, we recognize that some are more
plaintiff friendly, and some are more defense
friendly, and so the plaintiffs naturally
try to find those courts that are plaintiff friendly.
The defendants want defense
friendly courts. We tried the first case in
Texas. Texas has a reputation for
being plaintiff friendly, realistically I think at this
point in time, it’s probably not.
Our judge was appointed to the
bench by George Bush when he was Governor of Texas.
President Bush, is certainly no friend to trial
lawyers. We have an appellate court
system in Texas that is entirely Republican.
There will not be a Democratic
judge that will ever see the Vioxx case we have,
we tried in Texas, or the ones pending right now
to my knowledge. In New Jersey you’ve got a
different scenario. You’ve got a court system
that’s very friendly, ideologically at least,
with big pharma. Pharma has a home in New
Jersey, has great tort reform in New Jersey,
and until we got the punitive damage finding against Merck,
had never been held responsible for punitive damages in New
Jersey under the current state of the law.”
Prof: If you Google
“judicial hell-hole” you will find a map showing the
most plaintiff friendly jurisdictions in the country.
The huge ideological battle and
political battle which is in progress, about federalizing and
capping tort law awards, is out there.
Just go “tort reform”
or “judicial hell-holes”
and you’ll get the flavor of it.
“So New Jersey is somewhere that I think Merck
” “The Harvard
Business School slide that I’ve put was not the first slide I
showed, but it certainly was in my
opening statement. I wanted the jury to understand
that when– before Ray Gilmartin came on
board, Merck–which was 1994,
Merck was run basically by a CEO named Dr. Vagelos and Dr.
Vagelos is a world-renowned
doctor, phenomenal doctor. When Ray Gilmartin came on
board Merck didn’t hire a world-renowned doctor to run the
company. Merck didn’t hire a
world-renowned chemist, or even a nationally known
chemist. Heck, I’d have taken a local
chemist. They didn’t hire a pharmacist,
someone who had experience with pills and medicines on even a
local level, much less a national level.
What Merck did is they took a
different direction. They changed directions from
the Vagelos days, Dr. Vagelos days,
and they hired an MBA which I have a lot of respect for MBA’s,
but I think we need to put into context what it was speaking to
within the Merck culture. It was saying no longer is
science running our company, we’re now going to run this
company along economic terms as a business,
and Ray Gilmartin came in, as a Harvard trained MBA,
who had really no science background whatsoever.
It was an–I put the Harvard
Business School slide up to put a visual image to go with the
intellectual concept that Merck was choosing to be a business
first company not a patient– When we tried the Ernst case,
I was stunned at the opening that Merck gave.
Understand Bob Ernst died from
what’s called sudden cardiac death.
Sudden cardiac death means you
are dead by the time you’re in the hospital and the cause is
not something they can easily trace,
but it’s clearly a heart problem.
The sudden cardiac death was
attributed to an arrhythmia, which is a ventricular
fibrillation for him, his heart was quivering,
and the question ultimately becomes,
what caused that heart quivering arrhythmia?
according to the Merck Manual,
it’s caused by a heart attack, but it can be caused by an
electrocution, it can be caused by inhaling a
lot of salt water in a drowning, and it can be caused by being
exposed to hypothermia. Clearly none of those is what
had happened to Bob Ernst. Bob Ernst had had a heart
attack. I was stunned in opening when
the Merck lawyer stood up and told the jury,
disingenuously I believe, that if the jury looked at the
coroner’s report they would see that they coroner said Bob Ernst
had not had a heart attack, Bob Ernst had died from
arrhythmia secondary to arthrosclerosis.
Well, those are both caused by
a heart attack. Someone may have died from a
loss of blood okay, but if someone was shot,
and it was the gunshot that caused the bleeding and the loss
of blood, it’s disingenuous to stand up
and tell a jury, well they didn’t die from the
bullet, they died from loss of
blood.” I was shocked by that because I
thought it was a misrepresentation,
and I think Merck did it thinking they could get away
with it because no one had ever been able to find the coroner
and ask her what she meant, and so I don’t have any
testimony to the contrary, we just have a report.
I went back to my office and I
said, ‘I want the coroner.’ And they said ‘We can’t find
the coroner.’ I said ‘We can find anybody
except Bin Laden, find the coroner.’
We hired a couple of PI’s,
we found the coroner doing pathology work in the United
Arab Emirates Abu Dhabi. I shot her an email asking her
if she would mind if I spoke with her.
She emailed back and said she’d
be glad to speak with me. I called her on the phone and I
said, here is what was said about this case in opening,
here is what your autopsy said, tell me about it.
She said ‘Well he died,
under an autopsy I have to put the physical cause,
physical cause it was a sudden cardiac death with an
arrhythmia, secondary to arthrosclerosis.’
I said ‘Well how does that kill
you’? She said ‘Easy,
you have a heart attack.’ I said ‘Really?’
She said ‘Of course,
that’s the only thing that causes it.
Arthrosclerosis causes a heart
attack; the heart attack causes an
arrhythmia.’ She said ‘Unless he was
electrocuted,” she said ‘Was he electrocuted?’
I said ‘No.’
She said ‘Okay.’
I said ‘Would you come over and
explain that to the jury?’ She said ‘I would be glad too,’
so she came over. Well Merck threw a fit because
Merck says we never would have told the jury what we did if
we’d known Lanier was going to be allowed to tell the truth
about it.” Prof: That film is
almost an hour long. We had it made for the MBA’s a
couple of years ago. Mary Pat, you’re not the
coroner but if I asked you, is there–is another set of
relationships that involve Merck,
that were behind the scenes in all this,
and what you know about it, help me out.
Well in addition to all the
plaintiffs who brought cases against Merck,
Merck also had taken out insurance policies for product
liability and liability exposure insurance,
and they took them from a bunch of companies like Munich
Reinsurance and at the same time that all these cases were going
on, Merck was trying to collect on
those policies. Basically they wanted money
because they had to pull Vioxx and all the exposure,
they were losing a lot of money in profits that way.
These insurance companies were
saying, “Well you are exercising a
breach of warranty, because when you took out these
policies you basically told us that this sort of a thing
wouldn’t happen, but we’re saying that you knew
something like this would happen.”
Prof: Did the company
your close relative represented end up paying or not?
Student: They paid some
of the damages but not all. Prof: Some sort of a
negotiated settlement? Student: Yeah.
Prof: Let me finish this.
The ultimate outcome was a
negotiated settlement amounting not to $12.5 billion dollars as
Mark Lanier thought or claimed to think, but $4.85 billion.
What happens is the Court
system creates a class action suit and then settles the class
action suit in a way which creates a scoring system for the
plaintiffs, the tens of thousands of
plaintiffs. The score you get depends on
how long you used the drug, and how severely you suffered,
and how plausible the causal connection between what happened
to you and the drug is. For example,
if you took Vioxx for a short period of time but were a 280
pound diabetic, with a major smoking problem,
and a quart a day bourbon problem,
the odds were that you weren’t going to get a lot of money out
of the settlement, so it’s a mechanical system.
And I personally believe that
when used within reasonable limits common law is a way of
protecting relatively small people against large companies.
The adjudication of that
boundary, which is now in progress, is very important.
The killer for large companies
is the transaction costs of settling so many cases can
themselves be prohibitive. Okay, exam on Wednesday and
back to work on Monday.