Part 1 Enron Redux, The Valeant Pharmaceuticals Debacle



Part 1 Enron Redux, The Valeant Pharmaceuticals Debacle

By Richard E Davis, JD

How Better Information Governance Practices Would Have Helped Pershing and Sequoia Save Billions 

This is Part 1 of a 2 part series discussing the Valeant debacle. The purpose of Part 1 of this two part paper is to discuss information governance best practices and technologies and their impact on enterprise compliance and improved corporate governance. Part 1 will discuss the recent decline of pharmaceutical juggernaut, Valeant Pharmaceuticals, and the abject failure of their leadership and investors to avail themselves of best practices for information governance will be identified and explored. Part 2 will focus on the e-Discovery and computer forensics aspects of what will likely unfold over the coming months.

Detailed allegations of bad conduct by Valeant and its affiliate Philidor, as well as the fiduciary indifference of mega investors, Pershing Square Capital Management, LP and Sequoia Fund, Inc. will be examined.  We will show that the management practices of Valeant, despite its having touted “strong high-integrity management” to investors, were in fact devoid of integrity.  We will discuss how certain actions which adversely impacted the company value could have been discovered through the use of operationalized information governance technology and a stronger commitment to good corporate governance. Action speaks louder than words, so that it is no longer sufficient to make mere future representations about transparency and visibility into business practices. The best approach to detecting and avoiding patterns of deceit is to “trust, but verify”.

About Valeant

Valeant Stock Chart (VRX)

Figure 1 - Valeant Stock Price Chart illustration a Signficant Loss of Shareholder Value

Valeant Pharmaceuticals is a Canadian based pharmaceutical company that since 2008, experienced a run of good fortune under CEO Mike Pearson resulting in a ~4500% appreciation in the company’s value over a 9 year period. This run came to an abrupt end after a spate of bad press and material disclosures by activist investors beginning in Q4 2015. As recently as July 2015, Valeant was the largest publicly traded company in Canada with a market cap of $90 billion USD. As of today, Valeant’s precipitous decline in value is characterized by a ~73% loss of its share price which has reduced its market capitalization to about $24 billion USD. When large publicly traded companies suffer, so too do their investors.

One of Valeant’s primary investors, Pershing Square Capital Management, is under scrutiny for the way they aggressively accumulated 9.9%[1]of Valeant’s outstanding shares, notwithstanding notice of potential issues with the company. Another casualty of the Valeant slide, the Sequoia Fund run by investment firm, Ruane, Cunniff & Goldfarb was hit by a $2 billion loss.  Sequoia, a stalwart Berkshire Hathaway safe haven for over 20 years, at one point had a mind boggling 32% of its portfolio tied up in a long position in Valeant despite its “policy of not investing more than 25% of assets in one industry”, let alone one company[2]. For the management teams of many companies in today’s high pressure markets, their daily reality is encapsulated in the following simple statement – “as long as the stock price keeps going up, information and corporate governance be damned”.

It is not uncommon to see meteoric rises and falls in corporate valuations, but what makes this particular story interesting are the allegations of sinister and commercially unethical behavior of Valeant’s employees and affiliates that have called its value proposition and business model into question.  Of equal significance are the questions raised about the judgment calls of the company’s investors. Valeant’s conduct to control the manufacture and distribution of drugs in the consumer market is illustrative of a conspiracy-like plan of manipulative pricing, deceptive billing and revenue booking.

Therefore, the question remains, “what information governance technologies, principles and tenets could have helped identify problems with the Valeant business model?” Had the company’s independent directors leveraged readily available and reliable information governance technology and processes, then, all of the activities that Valeant and its affiliates engaged in could have been uncovered and remediated. Before we attempt to answer the question posed above, let’s take a closer look at the Valeant business model.

The Valeant Business Model Part 1 – Acquire Companies With High Brand Recognition Products

Anyone familiar with patent law will have heard the term “patent troll”. Colloquially speaking, a patent troll is an individual or entity that acquires specialized, not easily substitutable IP, then waits for the IP to be infringed upon, and then sues the infringer or “cajoles” the potential infringer into a licensing agreement. Patent trolls may or may not attempt to commercialize their patents and in many instances will pick a group of target companies that have potentially infringing products or technologies against which to file infringement actions. For those targeted, it is often cheaper for companies to simply settle than go through what may be a costly and lengthy litigation process.

While Valeant’s business model does not quite earn it the moniker of patent troll, their model bears some strategic similarity to that of the troll business model in that Valeant’s approach has been to buy up brand drugs which are not easily substitutable or have not yet gone over the patent cliff in order to garner a greater share of the market for certain treatments. Over a period of several years beginning in 2008, Valeant obtained significant rounds of funding from hedge funds including but not limited to Sequoia Fund Inc. and Pershing Square Capital LP. They then went on to use the funds to brilliantly and deftly acquire companies and drugs around the world. Valeant then went on to mark up their acquired drugs and products significantly. In short, Valeant is an adherent to what we refer to as the Shkreli business model. If the name Shkreli is not familiar, think back to September of 2015 when news broke about Turing Pharmaceuticals[3]. Turing, under the leadership of then-CEO Martin Shkreli[4], a former hedge fund and entrepreneurial wunderkind, jacked up the price on an AIDS drug they recently acquired by over 5,000% from $13.50 to $750.00 per dose. Literally overnight, Shkreli became the most vilified man in America and the poster child for corporate greed run amok. The similarity between Turing and Valeant pricing strategy is so great that on page 8 of a Valeant investor presentation on strategy, Turing Pharmaceuticals was explicitly referenced in a discussion of pharmaceutical industry pricing.

Valeant and other companies in the pharmaceutical vertical that adhere to the Shkreli model (‘Shkrelcos‘) generally forgo entirely the more traditional route of organic innovation and R&D process common to many drug manufacturers. When a leveraged company pays a high price for an asset, the name  of the game is rapid ROI which can only come in a finite number of ways – namely price increases and expansion of distribution. Once a Shkrelco acquires IP and or products, it then raises the price on IP licensing or medications for which there is usually no generic substitute. If there are generic equivalents for a Shkrelco’s brand drug regimen, then the Shkrelco can employ a number of tactics including the use of “payment assistance” programs to steer consumers to the non-generics in order to drive revenue. In ideal economic terms, the Shkrelco business strategy is characterized by creating rapid corporate revenue growth and valuation by cornering the market on a particular drug or technology for which there is relatively high demand inelasticity, but if the brand drug falls off the patent cliff, then the customer access to resulting lower priced generic equivalents must somehow be constrained. While often maligned as a business approach that has a tendency to result in corporate behavior that raises the specter of RICO and antitrust concerns, the Shkrelco’s approach is legal and effective, although generally perceived as running counter to public interest and public policy.

The Valeant Business Model Part 2 – Own the Supply & Distribution Chain

Mike Pearson deserves credit for delivering on the promise of Valeant’s beautiful portfolio of drugs. It is extremely rare that a CEO can generate a 45x return in 7 years. Having amassed a trove of brand name drugs whose market share needs to be preserved and grown, he set out to protect Valeant’s portfolio by implementing a perfectly logical and sound business strategy of forming distribution arrangements with pharmacies that would dispense drugs directly to patients and then bill the insured patient’s benefits provider. In the face of stiff competition from generic drugs which paying insurers would rather see prescribed to patients, Valeant’s relationships with these pharmacies gave them the requisite control of the distribution conduit to the patient consumer. The primary pharmacy Valeant worked with was the now defunct Philidor Rx Services, LLC which received an investment from Valeant of nearly $100 million USD and an option to buy them. Once Philidor was on line, it obtained agreements with the largest benefits providers including CVS Caremark, United Health Group, Walgreens and OptumRx.

Interestingly, the Philidor transaction details, seemingly material, were never publicly disclosed to investors[5] and from a corporate governance perspective, a disclosure would have been preferable. As it turned out, Valeant’s relationship with Philidor was so exclusive, controlling and complete, it effectively made Philidor a “captive pharmacy.” From an economic and managerial perspective, it effectively meant that Philidor was run by Valeant executives[6], a material fact that from a governance perspective might well have given investors and directors a reason to engage in more rigorous analysis of the relationship’s economic implications.

Functioning as Valeant’s primary distribution conduit to the consumer with a mandate to grow the pharmacy network, Philidor went on to acquire and affiliate with other dispensing pharmacies which gave it access to a number of unique pharmacy NPI numbers (National Provider Identification numbers issued by the Centers for Medicare and Medicaid Services). At this stage of the game, Valeant not only controlled the manufacturing of its drugs, it also controlled distribution.

Manipulating the Supply Chain to Drive Revenue

As mentioned above, some business models can lend themselves to behaviors evincing market manipulation which can raise and evolve into RICO and/or antitrust concerns. This is particularly the case when the motive, means and opportunity to control the supply chain in “unnatural ways” becomes economically expedient.  For Valeant, a captive Philidor soon meant that it could ensure that more expensive and profitable brand name drugs from the Valeant portfolio were being prescribed to patients, despite the fact that much cheaper generic equivalents were available for prescription. One of those techniques was to offer internet coupons under a patient assistance program that reduce or even eliminate patient co-pays if they used a Valeant affiliated pharmacy (see examples below)[7],[8], much to the chagrin of the insurers wanting to pay for less expensive generics for their insureds.

Figure 2 - Jublia Incentive Coupon

Figure 3 - Other drugs in the Valeant co-pay reduction program.

The Wheels Start Coming Off the Valeant Tricycle

Although Valeant’s alleged product steering and control of Philidor drove massive amounts of revenue, the summer of 2015 marked the turning point for this Shkrelco. Throughout July and into August 2015, Valeant’s share prices exceeded expectations with a rosy outlook for the future. The following month, on September 20th, news about Turing Pharmaceutical’s 5000% price increases hit the wires and within 24 hours, Hilary Clinton, was tweeting about pharmaceutical industry “price gouging.” On the September 21st Valeant disclosed its relationship with Philidor RX. Within a week, a bipartisan US House Committee subpoenaed Valeant about their pricing strategies. By October, seismic rumblings came to a head in a tsunami of bad news. On October 21, 2015, the Citron Research Group published a report[9] with damning allegations including assertions that Valeant employees were using manufactured alter egos to control what was assumed to be their largest “independent” distribution channel, Philidor Rx Services and its affiliates. The Citron Report called the Philidor affiliates “a network of phantom pharmacies” that were for all intents and purposes, extensions of the Valeant entity. The Pershing Square hedge fund allegedly lost $600 million in “seconds” after the Citron report hit the wires.

The Phantom Pharmacy Menace, the Unfortunate Consequences for Philidor and Valeant

For the last decade or so, phantom pharmacies have been linked to sophisticated fraud schemes costing taxpayers and insurers over $60 billion USD annually. In the most extreme cases, phantom pharmacies fraudulently obtain doctor and patient insurance ID information to write fraudulent prescriptions for expensive drugs that were never prescribed; the fake prescriptions are then submitted to Medicaid and Medicare for reimbursement. The allegations in this case were that Valeant controlled Philidor and a network of phantom pharmacies used to steer CVS, United Health Group and others towards expensive drugs being sold by Valeant as well as rebill benefits providers by switching out the ID’s on rejected invoices to hide the fact that invoices were previously rejected for noncompliance. To make matters worse, Valeant created phantom accounts to which they could generate fraudulent invoices to “deceive auditors and book revenue.” This is as bad an allegation as there is.

It was previously mentioned that Philidor became affiliated with other pharmacies to extend its reach to consumers. It had attempted to obtain a California license and that application was rejected in May 2014 after the California Board of Pharmacy accused it and its representatives of submitting “false statements of fact” in its application. The allegations were that Philidor intentionally provided false information when delineating the pharmacy’s owners, its accountant and names of individuals authorized as signatories to conduct financial transactions on behalf of the company. 

Rather than be denied, Philidor “back doored” market access by setting up a company, Isolani, to buy a licensed California pharmacy, the R&O pharmacy, so that Philidor could sell Valeant’s drugs in California, a state in which it was denied a permit to do business. Although the Isolani acquisition of R&O was never consummated, Philidor began to book Isolani / R&O revenue as its own. The phantom pharmacy allegations against Philidor RX began to surface when benefit provider OptumRx notified Philidor of billing irregularities concerning certain prescriptions for which OptumRx would not provide any reimbursement to Philidor.  OptumRx directives to Philidor were that it was to cease and desist its attempts to collect monies from OptumRx that were improperly billed. But, rather than comply with the cease and desist letter, Philidor promptly resubmitted invoices to OptumRx using the NPI number of other pharmacies under its control. To reiterate, Valeant’s investment in Philidor effectively gave it total control over Philidor.

Where were the information and corporate governance checks and balances? Why did it take a report by an activist short seller to reveal this massive alleged fraud? Simply put, had solid information and corporation governance discipline and technologies been in place, a thoughtful outside or independent director would have been able to discover this information long before the Citron Research report and taken action to remediate the resulting governance lapses.

How Do Venerable Investment Houses Managing Tens of Billions of Dollars Get Flim Flammed and is The Pharmaceutical Industry is Highly Susceptible to This Type of Activity?

Almost without exception, many attractive investment targets that ultimately lose their luster have started off well enough. Such was the case with Valeant. As mentioned previously, companies that do not organically develop drugs but rather acquire them, often find themselves under pressure to generate revenue to pay back investors.

The short answer to the caption question is that even the shrewdest investors can suffer from “margin myopia” which occurs when all that matters to stakeholders is the bottom line and governance best practices are seen as obstacles to rapid return on investment. This myopia blinds investors to the mechanics and behaviors that can damage the organization in the longer term. To help address and ameliorate some of the concerns raised in the Citron report, the Valeant board established an ad hoc oversight committee in reaction to the symptoms of the problems. The practical reality which will be emphasized in the conclusion is “had some of the information governance technologies and processes related to data classification and monitoring been in place, the requisite oversight would have been operationalized and run by a formalized committee from the very beginning, instead of reactively after the fact.

With billions of dollars at stake, it makes one wonder, just how do hedge funds conduct the requisite due diligence and implement the governance checks and balances to protect themselves and their stakeholders from the “the fox guarding the henhouse” scenarios that lead to bad behaviors by companies in which they invest. 

The revenue generating steering practices of Valeant and its affiliate Philidor are somewhat reminiscent of amateurish but effective penny stock “pump and dump” schemes where a company would avail itself of obscure and untested rulings used to consolidate outrageous revenue numbers or in the worst cases simply engage in outright fraud. If sophisticated money managers like Bill Ackman, one of Valeant’s largest investors could fall prey to such alleged duplicity, what of the other funds out there managing hundreds of billions of dollars in aggregate across many verticals? In a 4-hour call with Pershing’s investors back in October of 2015, Ackman reassured them that Valeant was not “Enron Part Deux” and that Valeant would work out its legal woes and rise from the ashes that are for now, bright burning embers. He’s essentially doubled down on the investment by stating “if we had more capital, we would put a lot more into Valeant at this time.”

Proactive Governance vs. Reactive Forensic Analysis

With standard surveillance and data analytics tools, these fraudulent practices could have been discovered from the outset by the management of the investment groups as well as the company’s board of directors. Anyone can falsely attest to a certification, public requirement or filing; even modest vigilance and monitoring will more often than not discover the fraudulent nature of activity. Our estimate is that an investment of $2 - $5 million dollars in an information governance technology platform and service coupled with a top down commitment to corporate governance would have saved hedge funds billions of dollars in their investments and an unquantifiable loss of goodwill for many years into the future. 

Getting one’s arms around what’s really going on in a company in relation to its business practices can be a function of proactively using subject matter experts to monitor, sample and analyze data to look for patterns and anomalies as a part of an ongoing compliance or information governance function. It can also be a function of getting burned and reactively deploying those very same tools and subject matter experts at a significantly higher cost and risk of disruption to engage in discovery function.

Figuring out What Went Wrong - A Real Life Use Case

The following example is a real life “reactive” use case that is germane to the Valeant debacle in that similar techniques will ultimately be used to figure out what went wrong.

Several years ago, a NY billionaire bought a company on the West Coast. Things were going swimmingly well until a few months after the deal closed. It turns out that the price this wealthy individual paid for this West Coast company was based on a sales trajectory that may not have been grounded in what FASB and GAAP revenue recognition principles would today recognize as legitimate sales of goods. To help figure out what was going on, I was retained along with a forensic accountant, “Dave”, to fly out and ferret out the facts. My job was to:

  1. Sequester the accounting system and all associated tape backups.
  2. Get the admin password to the SQL server instance, connect and join the tables that contained the relevant transaction records over a certain period of time.
  3. Export the data so my forensic accounting colleague, Dave, could do his magic.

The forensic exercise was a thing of beauty. In less than 24 hours, we uncovered what we suspected - a classic case of a company booking revenue on sales that weren’t really sales in the GAAP/FASB sense at all, which in some respects is similar to that which transpired in the Valeant/Philidor world. The people who engaged in this fraudulent activity did so to create a sales valuation of their company which triggered exorbitant bonuses upon the closing of the deal. Needless to say, after presenting this information to the client and his lawyers, the deal was rolled back, monies were disgorged and the fraudster’s fortunes turned in a matter of days. The takeaway point is that the work which Dave and I performed could have occurred before the deal closed as a matter of due diligence, thus avoiding embarrassment and the costs associated with the post-closing investigation.


What happened at Valeant can be described as an epic corporate governance failure. If theories as to why the company foundered are substantiated from a forensic accounting and discovery perspective, the “high integrity management” touted in Valeant investor presentations will be shown to have been a sham. This calls into question the judgment, fiduciary responsibility, diligence and oversight that the market has come to expect from the likes of venerable investment houses and management teams associated with Pershing Square and the Sequoia Fund. The fundamental questions that we seek to answer are:

  1. Could the alleged shady activity of the Valeant and Philidor management teams have been discovered sooner by applying a framework of analysis and monitoring as illustrated in Figure 4 below?

Figure 4 - Information Governance Framework for Board Oversight

  1. Did the performance of Valeant disincentivize Pershing and Sequoia managers to forgo their own internal investment standards, checks, balances and the oversight necessary to protect goodwill / investor value in lieu of profits? 

  1. Could a modest investment in quarterly risk gap analyses which leveraged governance tools and enabled risk reporting mechanisms have prevented such a catastrophic loss of investor value?

Based on our assessment of the situation to date and from information publicly available, we conclude that the answer to all three questions above is a resounding “yes”. The net result is that an independent board with the requisite resources could have identified and headed off the behaviors that caused this debacle. Those resources would consist of a risk analysis team of data/information governance experts with cost effective, state of the art tools capable of conducting the monitoring, surveillance and investigation functions described in Figure 5. Given the size, revenue velocity and regulated nature of Valeant’s vertical, a team the likes of which I describe SHOULD have been place, especially with the billions that Pershing and Sequoia sunk into them. This team would have been able to provide board members and fund management with the assurances that Valeant company operations were being subjected to the informational and behavioral scrutiny that the company’s business model necessitated.

The bottom line is that astute, educated investors should be circumspect if they do not receive assurances that the monitoring and surveillance activities described above are undertaken on a regular basis by companies they sink large amounts of dollars into. If conservative investment proponents like Warren Buffet rely on them to provide value, the name of the game is long term preservation of that value; not meteoric performance followed by a catastrophic, unrecoverable loss.  Figure 5 above illustrates common corporate data sources which could and should have been independently monitored and subjected to analytics with minimal adverse impact to the operations of the company. Sadly, it appears that the tools and methods discussed above will be employed in a forensic and discovery post-mortem exercise characterized by a blizzard of legal filings. Stay tuned for Part 2 of The Valeant Debacle: Where the Bodies are Buried, where we’ll discuss the likely next steps including the electronic discovery challenges to be faced by both Valeant/Philidor and the prospective plaintiffs in the context of a panoply of civil and possibly criminal actions.

[1], last visited March 10, 2016.
[2], last visited March 10, 2016
[3], last visited March 10, 2016
[4]Valeant’s downward spiral preceded Turing’s bad press, but Shkreli is the face most associated with this business model.
[5], last visited March 10, 2016
[6], last visited March 10, 2016
[7], last visited March 10, 2016
[8], last visited March 10, 2016

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