Shades of Enron in These Valeant Convictions
(Bloomberg Opinion) -- The conviction of two executives connected to Valeant Pharmaceuticals International Inc. brings to mind the Enron scandal and the subsequent prosecution of its top executives. Or at least to my mind.
Valeant, to be sure, was — and is — a far more legitimate company than Enron, which skirted the accounting rules to post earnings that didn’t really exist. Still, there are striking parallels between the two cases that can tell us a lot about what constitutes corporate criminality these days — and what doesn’t.
The two men who were found guilty Tuesday were Andrew Davenport, the chief executive of the specialty pharmacy company Philidor RX Services LLC, and Gary Tanner, the Valeant executive who managed the company’s relationship with Philidor — a company that had been started in 2013 with the express purpose of servicing Valeant’s needs.
What were those needs? Valeant’s business model depended on relentlessly raising drug prices, but insurance companies had become resistant to paying these exorbitant prices, favoring less expensive drugs instead.
Routing prescriptions through Philidor allowed Valeant to gain back market share for some of these drugs, while pushing the drug’s costs through the system — thanks to huge rebates the specialty pharmacy gave to insurance companies and other middlemen. One drug, Solodyn, saw its revenue increase by 56 percent in one quarter after Valeant started using Philidor to distribute it, according to internal documents obtained by Business Insider.
Philidor was, quite simply, an extension of Valeant. Some 90 percent of its business was Valeant-related. Valeant folded Philidor’s results into its own books. There were even Valeant employees working at Philidor under assumed names. In effect, Valeant was using Philidor to game the system.
But Philidor was kept secret from investors. Although short sellers had begun raising questions about Valeant, it was an expose by Roddy Boyd of the Southern Investigative Reporting Foundation in 2015 — revealing, at last, the connection between Philidor and Valeant — that sunk the company. It caused the stock to lose 90 percent of its value, led to accounting restatements, and ultimately triggered the resignation of its chief executive, Michael Pearson.
Government prosecutors soon opened criminal investigations into the Philidor-Valeant relationship, as well as Pearson and Valeant’s chief financial officer, Howard Schiller. But here we are, three years later, and the only people who have been convicted of anything are Tanner and Davenport. And their crime, it turns out, is not that they used Philidor to help Valeant game the system, but that they were engaged in a backroom kickback scheme. Absurdly, Valeant was portrayed as the “victim.”
How does this mirror Enron? Consider: Like Valeant, Enron had a secret that helped it meet its earnings goals. The company’s chief financial officer, Andy Fastow, controlled a series of special purpose entities that Enron used, as Fastow put it in his 2004 plea deal with the government, to “mislead investors by fraudulently improving the appearance of Enron’s financial statements.” Fastow also had a secret agreement with Enron’s CEO, Jeff Skilling, that allowed him to profit from the entities he set up.
Like Valeant, several short sellers had begun asking tough questions about Enron. But it wasn’t until the Wall Street Journal exposed Fastow’s special purpose entities in October 2001 that investors realized the company was cooking the books. By late December, Enron was bankrupt.
Government prosecutors opened investigations into the company and its top executives, but it took three years to indict Skilling and the company’s chairman, Kenneth Lay. One of the things that made that indictment possible was Fastow’s decision, six weeks earlier, to take a plea agreement.
In the agreement, Fastow pleaded guilty to two crimes. The first was fraudulently misleading investors. The second was engaging “in schemes to enrich myself and others.” In other words, on a much larger scale, he was doing backroom deals, just like Valeant’s Tanner.
It’s easy to understand why prosecutors bring cases like the one against Tanner and Davenport. Kickbacks, bribery, “enriching myself and others” — those are easy for prosecutors to explain and for juries to understand. The fact that Fastow was caught skimming from the company had a lot to do with why he pleaded guilty rather than face a trial.
But using special purpose entities to create fictitious earnings, or relying on a secret pharmacy to fool insurance companies — those are hard concepts to get across to a jury. In many cases, they may not even be against the law. Even if they are illegal, the executives have a measure of protection if the company’s accountants and lawyers have signed off on the maneuvers.
That’s why Angelo Mozilo, the former chief executive of Countrywide Financial, was never prosecuted even though he ran a company that was steeped in fraud. And it’s why not a single top executive from any major financial firm was charged with criminality after the 2008 financial crisis. It’s not that crimes weren’t likely committed. It’s that they were very difficult cases to bring. As Jesse Eisinger points out in his book, “The Chickenshit Club,” by 2008 prosecutors simply didn’t have the stomach to bring tough cases they might lose.
It’s true that prosecutors did ultimately indict, try and convict Skilling and Lay, and for that they deserve credit. (Lay died of a heart attack six weeks after the verdict; Skilling’s initial sentence of 24 years in prison was later cut to 14 years.) But I wonder if the government would have had the same success if Fastow hadn’t skimmed but had “merely” manipulated earnings for Enron — in which case he would probably not have agreed to become the government’s star witness. I have my doubts.
With Valeant, the case that really matters is not the one that revolves around money changing hands between Davenport and Tanner. It is the one that revolves around Valeant using Philidor to defraud — yes, defraud — insurance companies, Medicare and the health-care system. What Valeant did is Exhibit A in why the cost of drugs remains so stubbornly high.
In the fall of 2016, Bloomberg News reported that Pearson and Schiller were under criminal investigation, and that the Department of Justice was trying to build an accounting fraud case against the company.
I haven’t seen anything to suggest that that investigation has ended, but I don’t have much hope. The government simply doesn’t brings these kinds of hard cases anymore. But the real crime will be if Michael Pearson walks away from running a company that gamed the health-care system, while Gary Tanner goes to prison for taking a kickback.
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