The war over Lipitor - Full version

FORTUNE -- Just after Thanksgiving this year, if all goes as planned, the pharmaceutical industry will pass a historic milestone: A generic version of Lipitor -- the biggest-selling prescription drug on the face of the earth -- will go on sale for the first time in the U.S.

You'd think that in this era of generic-drug dominance, making the transition to a nonbranded version of Pfizer's vaunted cholesterol-fighting statin would be smooth, or at least controlled. And indeed, that's precisely how it seemed -- until just a few months ago. Now the process appears to have unraveled, leaving serious questions about who will make the cheaper form of Lipitor, whether the price will really drop, and most disturbing of all, whether patients will be able to trust that the medication is safe.

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As of today, Ranbaxy, India's largest pharma company and the 12th-largest generics maker in the world, is expected to launch generic atorvastatin calcium, as the molecule is formally known, in the U.S. market on Nov. 30. Under federal rules, Ranbaxy would enjoy six (very profitable) months in which it would have the exclusive right to sell it.

The problem: The Food and Drug Administration has accused Ranbaxy of "a pattern of systemic fraudulent conduct" over a period of years. According to the federal agency, Ranbaxy fabricated data in drug applications, took shortcuts in crucial quality tests, and violated a raft of additional manufacturing standards. So widespread and grave was the misbehavior that in 2008 the FDA barred Ranbaxy from importing 30 different drug products into the U.S. That ban remains in place today. Meanwhile, federal prosecutors have been negotiating a criminal and civil settlement with the company that could lead to fines and payments exceeding $1 billion, Fortune has learned from sources with knowledge of the negotiations.

Ranbaxy declined to comment for this article, as did the FDA. But in court filings and financial statements, the company, whose leading products in the U.S. are generic versions of Valtrex (for herpes), Aricept (an Alzheimer's drug), and Zocor (another cholesterol medication), has denied misconduct and asserted that it has cooperated fully with the government.

The result of the uncertainty about Ranbaxy and Lipitor has been market mayhem. Generic-drug companies are now feuding like greedy relatives at Lipitor's graveside as they wait to see whether Ranbaxy will maintain its status as front-runner. In March, Mylan (MYL, Fortune 500), one of the seven generic-drug makers hoping to sell Lipitor, sued the FDA, alleging that the agency's "indecision" and delay had made planning all but impossible.

A group of five U.S. senators has appealed to the FDA for clarity. In early March they wrote to the agency's commissioner, demanding timely information on who will be making generic Lipitor and when. The FDA, for its part, has made no public statements on Lipitor's fate. It has yet to formally approve or deny Ranbaxy's application to sell the generic.

The Lipitor stalemate is the culmination of the twisting saga of Ranbaxy, which continues to prepare for its product debut, despite the uncertainty as to whether it will occur. "For Ranbaxy, this is the fight of their lives," says a lawyer for a pharma company. "This is the biggest generic opportunity in history. None of us know where this is going to come out."

The battle begins

In the U.S., deciding which company gets to make the first generic version of a drug is a complex process that combines private litigation and government regulation. It's governed by the federal Hatch-Waxman Act. That law, which dates to 1984, created a pathway, the Abbreviated New Drug Application, for companies that want to sell a generic version of a particular medication.

Known by its acronym, the ANDA requires two simultaneous steps for any company that wants to be the first to sell a generic. That company must challenge the brand-name company in court and demonstrate that the various patents covering the original drug have run their course or are otherwise not valid. At the same time, the applicant must undergo a formal FDA review to see whether the proposed generic is the biological equivalent of the original and will achieve a similar level of concentration in the blood. The FDA also has to ascertain that the generics company is capable of manufacturing the medication in commercial quantities.

The reward for winning this arduous two-front war is six months of exclusive rights to sell the generic. During that period the winner will typically charge 70% to 80% of the brand-name price. After that, competitors are permitted to jump in, and the price usually drops to about 5% of the original drug's.

For generics manufacturers, being first can be the difference between making a fortune and making a living. (Indeed, six months of exclusive rights to atorvastatin will generate about $600 million in profits for Ranbaxy, according to analyst projections. This for a company with $1.9 billion in revenue and $459 million in earnings in 2010.) Getting first-to-file status has become so important that generic-drug executives have actually been known to sleep overnight in their cars in the FDA parking lot to make sure they're the first to file the paperwork.

So it went with Ranbaxy in a process that stretches back all the way to 2003 -- a time when the company was little known in the U.S. and anything but an obvious choice as the first to take on a blockbuster. That year Ranbaxy scientists reported they had developed a generic version of atorvastatin. The next day a company official flew from New Delhi to Washington to file an application with the FDA, as journalist Bhupesh Bhandari recounts in the book The Ranbaxy Story. That made Ranbaxy the first to file, with FDA front-runner status.

Though Wall Street analysts were dismissive at first, Ranbaxy's proposed formulation seemed credible. The company moved aggressively, and its legal maneuvering was deft. It embarked on litigation with a much bigger opponent, Pfizer (PFE, Fortune 500), that would span the next five years.

In June 2008 the companies announced a deal: Pfizer would no longer block Ranbaxy's efforts to sell generic Lipitor in the U.S., as long as Ranbaxy deferred its launch of atorvastatin until Nov. 30, 2011. The timetable extended Pfizer's patent by at least five months. But even this settlement, viewed as definitive at the time, did not resolve the matter. Ranbaxy still needed a green light from the FDA.

As this was happening, Pfizer made plans to manufacture its own generic Lipitor, to be distributed by Watson Pharmaceuticals, even as it continues to sell the name-brand version itself. Increasingly, brand-name companies are doing this. Once a drug goes generic, "the brand goes down the tubes in a hurry," says the pharma lawyer. Launching a generic, he says, is a "mitigation strategy."

Pfizer's generic could become the beneficiary of Ranbaxy's woes. If the FDA were to block or delay Ranbaxy's generic Lipitor, the Pfizer generic could have the field to itself. It "could negatively impact pricing" for consumers, says Randall Stanicky, a health-care and pharma analyst at Goldman Sachs. Pfizer could sell its generic at the highest possible price, and since Ranbaxy had been the first to apply to the FDA, no other competitor could sell it. That leaves Lipitor users in the odd position of rooting for Ranbaxy, a company with some unsavory history.

Accustations blow up

In August 2005, a whistle blower at Ranbaxy contacted the FDA, alleging that the company had committed extensive fraud in its generic-drug applications. The whistleblower's claims raised serious questions about the integrity of Ranbaxy's manufacturing and the safety of its drugs.

The ensuing four-year investigation, in which the FDA has teamed with the U.S. Department of Justice, turned up disturbing evidence, according to government filings (though none of the resulting allegations related to Lipitor). Crucial tests to evaluate how quickly drugs degrade, meant to be conducted over a months-long period, were actually performed over just a few days, with the records falsified to conceal that. On certain days quality assurance supervisors who purported to be on-site were absent, and their signatures were falsified. In yet another lapse -- this one potentially life-threatening -- Ranbaxy risked cross-contamination of penicillin with other drug products by manufacturing them in close proximity. Taken together, these and other forms of deception by Ranbaxy raised the possibility that what the FDA had approved and what patients were ingesting were two different things.

FDA inspectors were disturbed by what they found at the company's Paonta Sahib factory in India, where it planned to make generic Lipitor. They were "clearly shocked" that Ranbaxy was "totally flouting the rules," says one congressional investigator who later interviewed the inspectors.

By September 2008 the FDA had issued warning letters to Ranbaxy, describing what it referred to as "significant deficiencies" at Paonta Sahib and Dewas, the company's two biggest Indian plants. The FDA restricted the company from bringing some 30 drug products from those plants into the U.S. market. It was a severe blow, and Ranbaxy began intensive efforts to reverse the FDA's decision. Even as the agency blocked Ranbaxy from importing the drugs, it did nothing to remove existing stocks of those same medications from U.S. stores, and it permitted the company to sell another 50 drugs that were manufactured at other facilities. Those decisions helped provoke an unusual twist: a congressional investigation of the FDA (which fizzled out after a change in legislative leaders).

In February 2009 the FDA took another drastic step: It shut down reviews of all pending or future drug applications from the Paonta Sahib plant, effectively choking off the company's main pipeline into the U.S. market. The FDA imposes the restriction, known as an Application Integrity Policy, in cases where it has confirmed fraudulent activity.

Suddenly Ranbaxy's generic-Lipitor application, which relied on Paonta Sahib as the manufacturing site, seemed to be on very shaky ground. Ranbaxy appealed to the FDA for permission to shift the manufacturing location for atorvastatin to its U.S. plant in New Jersey. Since then, Ranbaxy's negotiations with the FDA and the Department of Justice have receded from public view, and the FDA has not yet issued an opinion as to whether it will permit Ranbaxy to make atorvastatin in the U.S.

Just before Ranbaxy's regulatory problems burst into public view, in June 2008, Daiichi Sankyo, Japan's third-largest drugmaker, purchased a majority share of the company. Ranbaxy had just won the rights to Lipitor. But within months Japanese executives were stunned to learn the depth and extent of Ranbaxy's woes, according to sources with knowledge of the FDA investigation. Daiichi Sankyo spent $4.6 billion for 63% of Ranbaxy -- and a year later wrote down the value of the acquisition by $3.6 billion.

A spokesperson for Daiichi Sankyo would say only, "The first-to-file status for atorvastatin was one of many reasons that Ranbaxy was an attractive acquisition for Daiichi Sankyo. However, our standing policy is not to comment on ongoing litigation. We continue to cooperate fully with the FDA to resolve the issues impacting Ranbaxy operations, but we will not speculate on the timing of any resolution or discuss any detail of those discussions."

No resolution in sight

The possible outcomes to the generic-Lipitor mess seem endless. Wall Street analysts map out complex flow charts to rehearse the potential scenarios and their market impact. Will the FDA allow Ranbaxy to launch atorvastatin in November? Might Ranbaxy cede its rights to the drug so that it can seal a deal -- or do just the opposite and cling to the rights as a bargaining chip? Can Ranbaxy defer its exclusivity period, thereby causing a pileup of generics companies forced to wait until Ranbaxy uses up its 180-day window? Such deferrals were permitted when Ranbaxy filed its application back in 2003, but the law has since changed to a use-it-or-lose-it provision. Because of the Lipitor market's sheer size, the differing scenarios could have repercussions across the entire pharmaceutical industry, from pharmacy benefit management companies to wholesale distributors to drugstore chains to, of course, patients.

Meanwhile, Ranbaxy's negotiations to resolve the federal fraud allegations, now three years long, drag on with no end in sight. Among the obstacles: The FDA is insisting on a meaningful settlement, and Ranbaxy is desperate to retain its rights to Lipitor. As this has occurred, Daiichi Sankyo has ushered two Ranbaxy CEOs to the exit and predicted an imminent resolution to the crisis.

The pressure on Ranbaxy is increasing, and Fortune has learned that in March it scheduled, then postponed, a meeting with the feds to resolve the fraud case. Some legislators seem to be growing impatient with the FDA. On March 10 the group of five U.S. senators seeking clarity from the FDA wrote to commissioner Margaret Hamburg, urging her to resolve "outstanding regulatory issues that may delay entry of generic versions of this medication." The letter focused on the costs to the government and consumers. Introducing generic Lipitor could save the public up to $6.7 billion a year, the letter states. The senators asked for a response in a week. So far they've received goodwill phone calls but no formal reply.

Soon after the senators' letter, on March 21, Mylan, a generic-drug maker with headquarters in West Virginia, filed a lawsuit against the FDA in federal court in Washington, D.C. The company alleges that the FDA's foot-dragging has hampered its efforts to plan its own generic-Lipitor launch. "FDA's indecision is permitting Ranbaxy to maintain a benefit to which it otherwise is not entitled," the complaint charges, requesting that the FDA deny Ranbaxy the exclusive rights to generic Lipitor.

The FDA responded on April 4 with a hard-hitting motion to dismiss Mylan's suit. The agency defended its silence, arguing that it is under no obligation to disclose confidential deliberations or to help Mylan with its business planning. Furthermore, the FDA noted that it was unclear whether the FDA would even approve Mylan's application to sell the generic. On May 2, a judge dismissed Mylan's suit, ruling that it can't intervene in another company's application.

Investors interpreted the FDA's stance in the Mylan case as a hint that the agency was planning to allow Ranbaxy to sell atorvastatin in November. The Indian company's shares rose on the news. It may indeed turn out that way, but with Ranbaxy still trying to hammer out its giant settlement, the only certainty is that there will be a few more twists and turns along the way.

--Katherine Eban, a Fortune contributor, has also written for Vanity Fair, the New York Times, and Self magazine. Her most recent article for Fortune was "Drug Theft Goes Big," in the April 11, 2011, issue.