According to Merck’s Code of Conduct, “We are committed to meeting or exceeding customer and regulatory requirements regarding the research, development, manufacturing, packaging, testing, supplying and marketing of our products. Quality means consistently satisfying requirements and expectations by delivering products and services of the highest value in a timely manner.”
Product safety and quality issues present an area of high risk for Merck. Because its business is concentrated on pharmaceuticals and high production volumes, Merck is exposed to litigation, regulatory, reputational, and recall related financial risks.
Merck received a warning letter in 2016, a Form 483 in 2015, and six Form 483s in 2014, indicating potential emerging quality issues in the company’s operations. Merck also faces controversies related to some of its products including Fosamax, Gardasil, and Avelox.
Given that the U.S. FDA and its international counterparts are increasingly prioritizing that drug manufacturers produce higher quality and more consistent outcomes in their manufacturing lots, we believe Merck’s management needs stronger oversight from its Board. To do so, we believe Merck’s Board should have multiple members with exceptional skills, knowledge, and experience in healthcare manufacturing to ensure long term, adequate oversight in this key operating area which is facing increasing regulatory scrutiny, competition and U.S. payer pushback.
An October 2016 PWC survey reported that 85% of board members in the pharma/life sciences industry feel that regulatory compliance risks pose the greatest oversight challenges to their boards. We are concerned that the Board lacks the necessary strengths and experience to meet these challenges.
Strong board oversight of management is also often improved with an independent chair, which can allow for better evaluation of the performance of senior executives and the company. An independent chair can also promote oversight of risk and assist in shareholder communications. In 2015, 55% of the S&P 1500 had an independent chair – up from 35% in 2004.
As Merck’s reputation with institutional investors improves, pressure may build for it to meet operating margin, earnings and cash flow metrics that support short-term shareholder return generation. In striving to meet these kinds of expectations, we believe strong governance practices can play an important role in keeping quality assurance, quality control, product safety, and manufacturing integrity a high priority.
In Merck’s 2016 proxy describing the “Experience and Qualifications of Particular Relevance to Merck” of its director nominees – experience in quality, safety or pharmaceutical manufacturing is not identified for any nominees.
Resolved: shareholders request that the Board issue a report (at reasonable cost, in a reasonable time and excluding confidential information) evaluating the merits and feasibility of Merck (1) strengthening Board expertise in pharmaceutical manufacturing and product quality and safety, (2) adopting an independent board chair leadership structure, and (3) any other related governance improvements the Board wishes to consider. The report should include sufficient information for investors to assess the quality of the evaluation and should provide the Board’s recommendations.