Cost, need questioned in $433-million smallpox drug deal By David Willman, Los Angeles Times
Once feared for its grotesque pustules and 30% death rate, smallpox was eradicated worldwide as of 1978 and is known to exist only in the locked freezers of a Russian scientific institute and the U.S. government. There is no credible evidence that any other country or a terrorist group possesses smallpox.
If there were an attack, the government could draw on $1 billion worth of smallpox vaccine it already owns to inoculate the entire U.S. population and quickly treat people exposed to the virus. The vaccine, which costs the government $3 per dose, can reliably prevent death when given [only] within four days of exposure.
Dr. Nicole Lurie, a presidential appointee who heads biodefense planning at Health and Human Services, cited a 2004 finding by the Bush administration that there was a "material threat" smallpox could be used as a biological weapon. "I don't put probabilities around anything in terms of imminent or not," said Lurie, a physician whose experience in public health includes government service and work with the Rand Corp. "Because what I can tell you is, in the two-plus years I've been in this job, it's the unexpected that always happens."
Worrying about worst-case scenarios is what biodefense planners do. In the case of smallpox, millions of Americans have no immunity because the vaccination of civilians ended in 1972. And there is no way to guarantee that a rogue regime such as North Korea is not holding smallpox.
Nonetheless, no such threat has been verified. The Bush administration suspected Saddam Hussein of possessing smallpox and other biological weapons, but inspectors did not find any after the U.S. invaded Iraq in 2003.
Still, pressure to move quickly and spend more has helped shape U.S. biodefense policy since the Sept. 11, 2001, terrorist attacks and the anthrax mailings that fall. Bush, in June 2004, signed Project BioShield, a 10-year, $5.6-billion initiative to fund the development and stockpiling of medications to counter bioterrorism.
Two months later, New York based Siga Technologies, Inc. purchased the rights to what became known as ST-246 from a Pennsylvania company, ViroPharma Inc., for $1 million in cash and 1 million shares of Siga's common stock. Over the next three years, the National Institute of Allergy and Infectious Diseases awarded Siga two research grants and a related contract, worth a total of $23.5 million, to develop the new drug.
From the outset, there was only one potential customer: the U.S. government. Unlike the smallpox vaccine, which remains potent for decades, Siga's drug is guaranteed for only 38 months.
Siga's controlling shareholder is billionaire Ronald O. Perelman, one of the world's richest men. Perelman and others at Siga's affiliate, MacAndrews & Forbes, have long been major political donors. They gave a total of $607,550 to federal campaigns for the 2008 and 2010 elections, according to records compiled by the Center for Responsive Politics. About 65% of that money went to Democrats. Perelman donated an additional $50,000 to President Obama's inauguration.
[At some point (whether in this administration of the prior one is unclear from the story), the federal Department of Health & Human Services began a solicitation process to acquire a smallpox biodefense drug for those who may be unable to obtain the smallpox vaccine withing the 4 day window of that drug's efficacy.]
On Oct. 13, 2010, Siga announced that the government intended to award it a contract for ST-246 worth as much as $2.8 billion.
But the federal contract required that the winning bidder be a small business, with no more than 500 employees. Chimerix Inc., a North Carolina company that had competed for the contract, protested, saying Siga was too big.
Officials at the Small Business Administration investigated and quickly agreed, finding that Siga's affiliation with MacAndrews & Forbes disqualified it.
In early December, officials completed a required "justification for other than full and open competition," which said an antiviral against smallpox was needed within five years and Siga was the only company able to meet that timetable.
Because the contract was no longer to be awarded based on competition and because the only customer was the government, officials sought to assess whether the company's proposed price was "fair and reasonable," as required by federal law.
In so doing, officials looked at how much government money had already gone into developing ST-246. Public records show $115 million in federal support, not including the stockpile contract.
After reviewing Siga's costs and the prices of other drugs produced in low volumes compared with commercial products, the HHS negotiators wanted to pay about $170 for each treatment. The company argued for more based on ST-246's potential value to the nation.
A financial analyst for RBC Capital Markets reported to investors in May that the agreed-upon price per dose appeared to be $255. He arrived at that estimate by dividing the $433-million contract by the 1.7 million doses to be delivered. Siga told The Times that this would give a rough approximation of the per-treatment price.
"Siga did not derive its price based on any cost information, and, from Siga's viewpoint, such information is not relevant to determination of an appropriate price," the company's chief financial officer, Daniel J. Luckshire, wrote to Lurie's office and others on March 4.
"Siga has created extremely valuable intellectual property, embodied in ST-246, and Siga has priced ST-246 based on the value of that intellectual property," Luckshire added.
On April 6, Siga's chief executive, Dr. Eric A. Rose, emailed the government's chief negotiator, D. Andre Early, saying the two sides were "at impasse." Rose said "any further negotiation should occur with a more senior official [with] the authority to take into account the important policy issues that surround this procurement."
Negotiations over the price of the drug and Siga's profit margin were contentious. In an internal memo in March, Dr. Richard J. Hatchett, chief medical officer for HHS' biodefense preparedness unit, said Siga's projected profit at that point was 180%, which he called "outrageous."
In an email earlier the same day, a department colleague told Hatchett that no government contracting officer "would sign a 3 digit profit percentage."
In April, after Siga's chief executive, Dr. Eric A. Rose, complained in writing about the department's "approach to profit," Lurie assured him that the "most senior procurement official" would be taking over the negotiations.
On May 13, HHS announced what amounted to the second awarding of the contract, worth between $433 million and $2.8 billion, depending on whether the government exercised options to buy more of the drug in future years. Siga hailed it as a "historic event for the biodefense industry."
Siga was awarded the final contract in May through a "sole-source" procurement in which it was the only company asked to submit a proposal. The contract calls for Siga to deliver 1.7 million doses of the drug for the nation's biodefense stockpile. The price of approximately $255 per dose is well above what the government's specialists had earlier said was reasonable, according to internal documents and interviews.
The apparent procurement controversy in this acquisition, apart from the political one this story alludes to, concerns when cost (including the cost concept of "reasonable profit") is to be a determinate of price. Here, Siga argued cost is "not relevant to determination of an appropriate price"; rather, price should reflect the "extremely valuable intellectual property" embodied in the drug.
Guam law (based on ABA Model Procurement Code law), in very general terms, requires, when there is only one bid (as there always is in a sole source solicitation), that price cannot be accepted unless it is first independently determined that "the price submitted is fair and reasonable". (See, 2 GAR § 3102(c).) The regulations allow cost principles to be used to evaluate prices for sole source procurements (2 GAR § 7101(b)((1)(b)(i)), and the cost principles specified are extensive and detailed. The regulations require the use of federal government cost principles when dealing with contractors operating according to federal cost principles or when federal assistance monies are used and specified in the assistance program or instrument. (2 GAR § 7101(j).)
Federal price and cost principles are even more extensive and descriptive. The general policy of federal contracting, again, is that prices be "fair and reasonable". (FAR Subpart 15.402(a).) The full application of the FAR will not be discussed here (in deference to my limited acquaintance with it), but the general principles are set out in Subpart 15.4 ("Contract pricing").
The FAR distinguishes between price analysis and cost analysis, and describes the methodology for each analysis in detail. (See § 15.404-1 (b) and (c).) It described price analysis as "the process of examining and evaluating a proposed price without evaluating its separate cost elements and proposed profit." Cost analysis, on the other hand, "is the review and evaluation of the separate cost elements and profit in an offeror’s or contractor’s proposal ..., and the application of judgment to determine how well the proposed costs represent what the cost of the contract should be, assuming reasonable economy and efficiency."
The federal approach is to avoid looking to cost to evaluate fair and reasonable value as a general rule, subject to exceptions. The admonition is to use "every means available to ascertain whether a fair and reasonable price can be determined before requesting cost or pricing data". (§ 15.402(a)(3).)
The usual exceptions to the rule of avoiding cost data are based on the concept that where there is market value data available, usually in respect of "commercial items", or other "adequate price competition", that will be sufficient to establish a fair and reasonable value. (See, § 15.403-1(b).) But when those factors are lacking, a look at cost data can be justified.
An exception is also made for a waiver of cost price determination. "The HCA may consider waiving the requirement if the price can be determined to be fair and reasonable without submission of cost or pricing data. For example, if cost or pricing data were furnished on previous production buys and the contracting officer determines such data are sufficient, when combined with updated information, a waiver may be granted." (§ 15.403-1(c)(4).) Thus, this determination must be based on relevant facts and not some vague judgment.
There is also a policy and methodology for determining the profit allowed under a fair and reasonable price. As expected, it's complicated (see § 15.404-4). Policy statements of government interest reflect the reality that undue profit squeeze is not good as an incentive for good performance, not good for quality and not good for maintaining a viable competitive marketplace for government purchasing.
However, there are many factors the government is intended to consider in evaluating a fair and reasonable profit factor, including (pertinent, it would seem to the case above), the "contractor risk" and "independent development" factors.
Under the contractor risk factor, generally speaking, the more contract risk a contractor assumes to deliver the item sought, the greater the profit factor might be. Under the independent development factor, "the contractor may be provided additional profit opportunities in recognition of independent development efforts relevant to the contract end item without Government assistance. The contracting officer should consider whether the development cost was recovered directly or indirectly from Government sources." (See, § 15.404-4(d).)
It is not the point of this post to judge whether the profit factor was properly evaluated or even if cost factors should have been considered, whether the solicitation was appropriately sourced, or whether any other claim might be made about the procurement. Rather, it is simply to point out some of the broader procurement issues that must be addressed, over and above whatever political intrigue there may be. Procurement issues, also, are usually easier to define and assess than political intrigue or influence, so tend, for my money, to be more productive in dealing with something that doesn't pass a quick smell test.
It can also be pointed out that the government is not bound to take the price offered or leave it. In fact, as Jim Nagle's book, the History of Government Contracting, points out, there have been numerous instances in the federal government's procurement experiences when the government has created competition when there wasn't any, or coerced it upon manufacturers when it has been necessary to do so. And when politics has not intervened. These are all issues lurking in this story.
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