Government Funding of Pharmaceutical Research and Development

U.S. government contracts can nudge companies toward developing drugs, countermeasures, and related diagnostics deemed essential to U.S. public health and safety and can alter a company’s priorities. For example, programs managed by the Department of Health and Human Services (HHS) in recent years have supported research for vaccines and therapeutics in the fields of influenza, anthrax, Ebola, and Zika.¹ In the last several years, HHS awarded an $8.9 million contract to support a new Zika diagnostic test,² a $43 million contract for development of a Zika vaccine (with options up to $130 million if development advances),³ and a $198.8 million contract to support development and licensure of an anthrax vaccine.⁴

Absent government funding, companies might focus only on treatments for more commonly-occurring conditions, even if they are not life-threatening. For example, innovation in the area of influenza vaccines likely would not be considered a “blockbuster,” and yet it remains important due to the potentially devastating consequences of an outbreak. Government funding, however, comes with numerous terms and conditions intended to protect taxpayer money and implement socioeconomic goals. Companies following standard accounting and subcontracting practices will be required to implement additional procedural and reporting safeguards. The following is a high-level description of just a few of these requirements to give an impression of the strings that attach to government contracts.

Accounting for Costs

Due to the nature of the work, research and development contracts are likely to be funded by government reimbursement of costs incurred rather than payment on a fixed-price basis. The U.S. government’s Cost Accounting Standards (CAS)⁵ and the Federal Acquisition Regulation (FAR) cost principles⁶ impose specific requirements to the calculation of costs incurred in the performance of a contract, and a company’s compliance is subject to rigorous review and audit by the Defense Contract Audit Agency.⁷ Always looming in the background is the healthy fear of termination for default, suspension or debarment, or even a False Claims Act (FCA)⁸ allegation for a failure to comply with cost accounting requirements.⁹

To comply with cost accounting requirements, a company must establish appropriate methods for calculating direct costs. This includes proper management of a timekeeping system that accurately records labor hours, and procurement processes that not only capture subcontractor and vendor costs, but also flow down numerous FAR and prime contract requirements to lower tiers. Implementation can be difficult, especially where processes are already in place for “civilian” purposes to minimize timekeeping burdens and streamline purchasing. A failure to implement appropriate systems can lead to incomplete reimbursement and wasted costs on the part of the company, not to mention the risk of suspension, debarment, and an FCA claim, as noted above.

In addition, CAS-compliant companies will normally be required to submit a Disclosure Statement (DS-1), detailing its methods for calculating indirect costs.¹⁰ The DS-1 must be revised whenever a company’s methods of calculating overhead, fringe benefits, and general and administrative costs change. Generally, during contract negotiations, the company and federal agency providing the funding will agree on provisional indirect rates to be charged to the contract, including allowable profit. To comply with the FAR, a company will be required annually to submit an Incurred Cost Submission (ICS), calculating the actual indirect costs incurred in the previous year, and adjusting those actual rates up or down from the previous years’ invoicing of the provisional rates through a true-up process. The actual rates in the ICS normally become the provisional rate for the next year, and the cycle continues through contract close-out. For many companies, sharing indirect cost data so openly with a customer can be daunting, but the spending of public funds warrants such transparency.

Subcontracting Requirements

As noted above, a company may have a perfectly good subcontractor or vendor management system in place for “civilian” purposes. Upon entering into a government contract, a company accedes to a critical extra step in its normal process: agency contracting officer approval of subcontracts.¹¹ It is possible to avoid subcontract-by-subcontract approval requirements by establishing an “approved purchasing system,” but the process of obtaining approval can be onerous and is therefore generally reserved for companies performing government contracts as a large proportion of their business.¹² Awaiting contracting officer approval can delay urgent purchases, and must be accounted for in program timelines.

In addition, the government uses contracts to encourage contractors to engage particular entities, such as small, disadvantaged, woman-owned, minority-owned, and service-disabled veteran-owned businesses as subcontractors. Contractors must agree to a small business subcontracting plan that commits to achieving the agency’s subcontracting goals, measured as a percentage of the dollar value of the total dollars spent under the contract.¹³

Even if a company already has a company-wide small business subcontracting plan as an element of its procurement program, it still may be required to implement small business subcontracting plans for each individual government contract, and to use good faith efforts to engage such suppliers in support of the contract. Meeting the goals of contract-by-contract small business subcontracting plans can be especially difficult for pharmaceutical companies, because they often subcontract to contract manufacturing organizations and contract research organizations for a large proportion of research and development programs, and these are often classified as “other than small” businesses. Indeed, there are many reasons, such as trustworthiness, volume discounts, and the complexity of technology transfers between the entities, that can limit the incentive to seek out new and untested businesses in these areas. Therefore, good faith efforts often require companies to look to other aspects of contractor performance, such as scientific writing and statistical analysis, to try and fulfill these small business requirements. Notably, under new rules, a prime contractor may include lower-tiered small business subcontractors toward the prime contractor’s goals in some cases, even if the first-tiered subcontractor is not a small business. Contractors are required to report twice a year on its small business subcontracting efforts in relation to the goals stated in their plans.¹⁴

Additional Reporting Requirements

Subject Invention Reporting

The Bayh-Dole Act¹⁵ (supplemented by Executive Orders 12591¹⁶ and 12618¹⁷) permit companies to keep title to certain inventions arising out of government contracts (“subject inventions”), although the government may retain title in certain situations, such as where the inventing company is not located in the United States or is subject to the control of a foreign government. In any event, the government retains a government purpose license as well as “march in” rights in subject inventions that apply when a company either fails to, or decides not to, commercialize a subject invention. In the pharmaceutical context, subject inventions could include a new manufacturing process, new drug administration methods, and other patentable or protectable inventions or discoveries arising out of government-funded research.

In order to keep title to subject inventions, contractors must meet the reporting requirements laid out in FAR Part 27 and FAR Clause 52.227-11.¹⁸ These require the company to report inventions to the agency contracting officer within two months of the invention being disclosed internally to the person responsible for patent matters within the company. The company then has two years to elect to retain title, and another year to file a provisional or non-provisional patent application. A company must be familiar with these reporting requirements, because a failure to timely report could lead to the government acquiring title. Even worse, should the government attain title, the government may also license rights to the development and commercialization of a subject invention to a competitor. While rare, the potential consequences could have a tremendous negative financial and reputational impact on a company and must be taken seriously.

Earned Value Management Reporting

The government, and especially HHS, has moved recently to requiring research and development contractors to comply with “Earned Value Management System” requirements. EVMS is a performance management tool that requires a contractor to divide projects into measurable cost and progress increments and to provide this costs-versus-progress data to the government monthly in a specific format.¹⁹ The level of detail required is dependent on the value of the contract. Here, too, a contractor may have a perfectly good “civilian” project management system in place, and yet will be required to add another layer of data consolidation and reporting in order to comply with the contract, including potentially purchasing particular software or hiring an expert.

Conclusion

Government funding is available to encourage research and development of pharmaceutical products that could contribute to the public health, even though the costs associated with development would normally be prohibitive or development of such a product would otherwise be deprioritized. A company seeking to enter this sphere should review requests for proposals carefully to understand the terms and conditions that will apply to a resulting contract, and the costs of compliance - and the risks of compliance failure - that accompany government funding must be added to a company’s assessment of priorities. The foregoing is only a small sample of the compliance requirements that will apply to a company that takes the leap and becomes a government contractor.²⁰ Once appropriate compliance systems are in place, government funding sources can help pharmaceutical companies conduct research and development in areas that may otherwise be put on the backburner for want of funds. 

1.  In 2006, HHS established The Public Health Emergency Medical Countermeasures Enterprise (PHEMCE) to “coordinate[] Federal efforts to enhance Biological, Chemical, Radiological and Nuclear threats and Emerging Infectious Diseases (EID) preparedness from a medical countermeasure perspective.” PHEMCE continues to address the medical countermeasures needed to protect against high priority threats that have the potential to seriously threaten national health security. Some of these high priority threats include anthrax, typhus, influenza, and Ebola. See https://www.phe.gov/Preparedness/mcm/phemce/Pages/default.aspx.
2.  https://www.phe.gov/about/barda/Pages/NewsReleases.aspx.
3.  https://wayback.archive-it.org/3926/20170127192443/https://www.hhs.gov/about/news/2016/09/26/barda-awards-funding-speed-development-zika-vaccine.html.
4.  https://wayback.archive-it.org/3926/20170129092815/https://www.hhs.gov/about/news/2016/09/30/hhs-supports-next-generation-anthrax-vaccine-advanced-development.html.
5.  48 C.F.R. Part 99.
6.  48 C.F.R. Part 31.
7.  DCAA includes links to guidance and relevant regulations online at http://www.dcaa.mil/Home/Guidance (last accessed July 18, 2017).
8.  31 U.S.C. §§ 3729-3733.
9.  The government could allege that such a compliance failure, and the resulting flawed invoices submitted, constitute false statements under the False Claims Act.
10.  48 C.F.R. Clause 9903.202-1. A Disclosure Statement is a written description of a contractor's cost accounting practices and procedures. The submission of a new or revised Disclosure Statement is not required for any non-CAS-covered contract or from any small business concern.
11.  48 C.F.R. Subpart 44.2.
12.  48 C.F.R. Subpart 44.3. A Contractors’ Purchasing System Review is performed by an appointed Administrative Contracting Officer (ACO), and it is not specific to any individual contract but rather the contractor itself. The ACO will review a contractor’s use of competition, evaluation of subcontractor responsibility, compliance with Cost Accounting Standards, and use of small business subcontractors, among other things.
13.  48 C.F.R. Subpart 19.7.
14.  48 C.F.R. Clause 52.219-9.
15.  35 U.S.C. Chapter 18. Public Law 96-517, https://www.gpo.gov/fdsys/pkg/STATUTE-94/pdf/STATUTE-94-Pg3015.pdf (last accessed July 18, 2017).
16.  https://www.archives.gov/federal-register/codification/executive-order/12591.html (last accessed July 18, 2017).
17.  http://www.presidency.ucsb.edu/ws/index.php?pid=33850 (last accessed July 18, 2017).
18.  48 C.F.R. Part 27 and 48 C.F.R. Clause 52.227-11.
19.  48 C.F.R. Subpart 34.2.
20.  In 1965, President Lyndon Johnson signed Executive Order 11246 granting supervision of federal contract compliance to the Secretary of Labor, and creating the department’s first Office of Federal Contract Compliance. The Executive Order prohibits federal contractors and federally-assisted construction contractors and subcontractors from discriminating in employment decisions based on race, color, religion, sex, sexual orientation, gender identity, or national origin. It also requires the Government to take affirmative action to make sure equal opportunity is given to employees in all aspects of their employment. Additionally, the Executive Order prohibits federal contractors from taking adverse employment actions against applicants and employees. Also, more recently President Obama issued Executive Orders that imposed additional requirements on federal contractors, such as Executive Order 13496, which requires federal contractors and subcontractors to notify employees about their rights under the National Labor Relations Act.