Alert: CA (practically) Outlaws Non-Direct Distribution of OTC Diabetic Test Strips in CA

On July 31, 2017, California governor Jerry Brown signed into law a bill deeming two types of conduct as unprofessional conduct: (1) submission of reimbursement claims by a healthcare professional for OTC diabetic test strips not purchased directly from the manufacturer or its authorized distributors (“direct-purchase”), and (2) a healthcare professional’s non-direct purchase.[1] This law became effective immediately on July 31, 2017.

Below, we will briefly cover the law’s requirements and answer any questions you may have about the law. If you have other questions, please contact us.

What does this law actually do?

Simply put, from now on healthcare professionals in California will have to purchase strips directly from the manufacturers or their authorized distributors (“direct-purchase”).

Under the law, “authorized distributors” are distributors that are authorize by the manufacturers to distribute the devices, and whose names are posted on the manufacturers’ websites. We expect to see the names of the authorized distributors on the Board of California’s website approximately by the end of September to the beginning of October.[2] Purchasing test strips from distributors not authorized by the manufacturers are deemed unprofessional conduct under the law, and will be subject to the Board of Pharmacy’s disciplinary actions.[3]

Why did the California legislature pass this law?

Section 8 of AB 602 states that the law’s purpose is to “immediately prevent the sale of nonprescription diabetes test devices that may have been tampered with or improperly stored . . . .”[4] Assembly member Rob Bonta – the lead author of this law – stated this law “will ensure [diabetics] receive the highest quality devices . . . without unnecessary cost increases,” and that the law “will . . . [prevent] cost increases, and [maintain] affordable, high-quality testing products for the patients who use these test strips daily.”

Can I be an authorized distributor?

Currently, the law does not prescribe any criteria or standards for whom the manufacturers should designate as authorized distributors. Absent further guidance from the California Board of Pharmacy, it seems for now that the California legislature has completely delegated to the manufacturers the authority to choose which companies may legally distribute diabetic test strips in California.

Practically speaking, existing primary distributors such as McKesson, Cardinal Health, or AmerisourceBergen are extremely unlikely to have any issues in being designated as authorized distributors. These primary distributors already have established relationships with the manufacturers and distribute many of the manufacturer’s products.

On the other hand, secondary distributors are unlikely to be able to become authorized distributors. For several reasons, such as transaction volume and the verification systems in place, secondary distributors do not have the same relationship with manufacturers as the primary distributors do. This means manufacturers are unlikely to designate secondary distributors as authorized distributors for diabetic test strips. Simply put there is no incentive to do so, and too much administrative effort would be required to verify each secondary distributor’s readiness to directly distribute the manufacturer’s products.

In short, if you are not a primary distributor, you may have a difficult time in being designated as an authorized distributor.

What will be the law’s effect on the industry?

We understand and commend the California legislature’s efforts to curb issues with diabetic test strips. But we see some problems here. Most importantly, this law may drive hundreds of secondary distributors out of the diabetic test strip market in California, leaving only the primary distributors in the market.[5] Essentially, the law would create an oligopoly for the diabetic test strip market in California. Contrary to the law’s original intent, this reduction in the number of distributors will result in higher prices to consumers, as well as potentially reduced access to the strips for  patients as shortages will likely arise.

Moreover, this could have larger ripple effects across the entire drug and medical device distribution market because secondary distributors rely on test strips – as low-margin / high-volume staple products – to lure in customers for other goods often ordered with the strips yet having greater margins.[6] Thus, when test strip sales decrease, secondary distributors will lose revenue from the sale of other that accompanied the purchase of the strips. Simply put, this law will result in the concentration of even greater financial advantage on a very few large primary distributors.

In our opinion, the most problematic part of this remedy is that under the new law, private manufacturers have the complete power to dictate the participants in the non-Rx diabetic test strip market in California. The state legislature has put its constituents (California consumers and diabetic patients) entirely at the mercy of publicly traded companies, which now, and quite suddenly, have the power to expand or contract the market and ultimately affect the supply of non-Rx diabetic test strips into one of the largest economies on earth. The legislature has also enabled the manufacturers and authorized distributors to rely on State-funded health inspectors and investigators to protect the private corporate interests. There are other, better ways to combat the perceived problems.

More practically, we are concerned that this law may result in the disintegration of the secondary distributor market in California, both for diabetic test strip supplies and other medical products with comparatively little benefit to public health. Secondary wholesalers are already under the jurisdiction of the state’s Board of Pharmacy as well as the Federal Food and Drug Administration (FDA). Regulating them out of existence will do little to help patients if there is no mechanism to prevent manufacturers and authorized distributors from raising prices by contracting supply. In such a scenario the result would be exactly the opposite of what the law had originally intended.

So what should be done here next?

Secondary distributors should immediately educate staff on the above development and be prepared for a reduction in the sales of the test strips in California (to be clear, the law only prohibits “acquisition” of test strips from persons that are not the manufacturer or its authorized distributor; the law does not directly prohibit sales of test strips). Secondary distributors may also begin the process of becoming authorized distributors, although this has only a low likelihood of success.

Separately, we recommend that the legislature consider modifying the current law to lessen its anti-competitive effects. An example would be to exempt from the law those secondary distributors or hospital members (e.g., purchasers of diabetic test strips) that have had previous and ongoing relationships. First, this would provide a low-risk way for the secondary distributors or hospitals to continue to purchase and distribute diabetic test strips. Second, perhaps as importantly, this would provide relief to hundreds or thousands of healthcare professionals that purchased test strips from secondary distributors before the July 31, 2017 effective date, believing them to be reimbursable. The new provision with this addition would read like the following (addition in bold italic):

“(t) The acquisition of a nonprescription diabetes test device from a person that the licensee knew or should have known was not the nonprescription diabetes test device’s manufacturer or the manufacturer’s authorized distributors as identified in Section 4160.5, unless the licensee had an ongoing business-supplier relationship with such person for such nonprescription diabetes test strips prior to July 31, 2017. The licensee shall document its prior ongoing relationship with the person.

(u) The submission of a reimbursement claim for a nonprescription diabetes test device to a pharmaceutical benefit manager, health insurer, government agency, or other third-party payor when the licensee knew or reasonably should have known that the diabetes test device was not purchased either directly from the manufacturer or from the nonprescription diabetes test device manufacturer’s authorized distributors as identified in Section 4160.5, unless the licensee had an ongoing business-supplier relationship with its distributor of the nonprescription diabetes test device prior to July 31, 2017. The licensee shall document its prior ongoing relationship with the distributor.

Afterward, the Board of Pharmacy could define the “ongoing business-supplier relationship” as:

“an association that exists when a manufacturer and a distributor enter into a written agreement under which the distributor is authorized to distribute the manufacturer’s products for a period of time or for a number of shipments. If the distributor is not authorized to distribute a manufacturer’s entire product line, the agreement must identify the specific products that the distributor is authorized to distribute.”

This is the same approach that FDA took when implementing the Prescription Drug Marketing Act of 1987 (“PDMA”) in its regulations promulgated in 2006 pursuant to PDMA.[7]

This modification would not be a comprehensive solution to the issues outlined above, but it would serve as a stopgap measure designed to prevent a complete disintegration of the secondary distributor market in California. At a minimum it would permit California healthcare professionals and secondary distributors to preserve the relationships and trust they have built, and for the patients to continue to benefit from them without suffering from sudden hikes in diabetic test strip prices; something patients are sure to see.

Eventually, the legislature may also consider modifying the law to include narrower and more focused solutions for the fraudulent reimbursement problem involving test strips, rather than a  blanket and indiscriminate regulatory approach under the new law.

For example, simply expanding the federal Drug Supply Chain and Security Act (“DSCSA”) requirements for prescription drugs to non-Rx diabetic test strips sold in California would be a focused and simple regulatory solution.[8] While the manufacturers may not be used to providing transaction documents for non-Rx devices, a direct-purchase statement, as outlined in DSCSA § 582(1)(A)(ii)(I)(aa) from the primary distributor could solve this issue. Adopting the DSCSA’s transaction history requirement would have provided some very good preventive controls against counterfeiting or grey-marketing of diabetic test strips.

California legislature should reconsider how existing regulatory regimes, enhanced penalties for fraudulent transactions, and tightening down on the documentation, record keeping requirements, and the use of pedigrees, for example, can keep prices down and ramp up the safety and security of non-Rx diabetic test strips.

We welcome any comments and opinions regarding this law. If you have any questions, please contact us at our Los Angeles, CA office at California@benjaminlengland.com or phone at 562-285-3400.

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[1] Amended § 4301 of the California Business and Professions Code states:

(t) The acquisition of a nonprescription diabetes test device from a person that the licensee knew or should have known was not the nonprescription diabetes test device’s manufacturer or the manufacturer’s authorized distributors as identified in Section 4160.5.

(u) The submission of a reimbursement claim for a nonprescription diabetes test device to a pharmaceutical benefit manager, health insurer, government agency, or other third-party payor when the licensee knew or reasonably should have known that the diabetes test device was not purchased either directly from the manufacturer or from the nonprescription diabetes test device manufacturer’s authorized distributors as identified in Section 4160.5.

[2] See California Business and Professions Code § 4160.5.

[3] See § 4301.

[4] http://leginfo.legislature.ca.gov/faces/billTextClient.xhtml?bill_id=201720180AB602

[5] And all this may happen in a very short time, because healthcare professionals will not be willing to risk any disciplinary actions from the Board of Pharmacy. The law defines both non-direct-purchases and reimbursement claims for such purchases as unprofessional conduct, for which healthcare professionals could face disciplinary actions. As readers may know, board disciplinary actions are serious matters for those working in self-regulated professions.

[6] “Loss leader pricing” is a common pricing strategy.

[7] “Ongoing relationship” was a term used in association with another definition in PDMA – “authorized distributor of record.” In the more recent law DSCSA, FDA defines a similar term “authorized distributor” completely differently, and the meaning of the term “authorized distributor” in DSCSA is not to be confused with the meaning California legislature conferred on the same term in this law.

[8] The DSCSA contains some preemption provisions, but those would not apply to a state’s regulation of OTC drug distribution as is the case here.

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