Former Valeant and Philidor executives charged in kickback scheme; how management got fooled, or so they say

Federal prosecutors filed charges against former Valeant Pharmaceuticals International Inc. (Laval Québec) executive Gary Tanner and former Philidor Rx Services LLC (Hatboro PA) CEO Andrew Davenport, alleging they engaged in a multimillion-dollar fraud and kickback scheme.

Charges filed against former @Valeant executive Gary Tanner and @PhilidorRx CEO Andrew Davenport Click To Tweet

The US attorney’s office alleged the two men conspired to promote Philidor to Valeant to win and control its business, according to the complaint. Mr. Davenport allegedly paid Mr. Tanner $10 million in kickbacks in exchange for his promotion of Philidor’s business, including by facilitating transactions that helped Davenport gain more than $40 million–and potentially tens of millions of additional dollars–from Valeant.

The complaint alleges the two worked without Valeant executives’ knowledge to shut out other mail-order pharmacies from getting Valeant business and helped persuade Valeant to buy an option in Philidor, according to The Wall Street Journal. Both were arrested in their homes early Thursday morning, Mr. Tanner in Phoenix and Mr. Davenport in Pennsylvania, the Federal Bureau of Investigation said.

In the complaint, the US attorney said Valeant’s chief compliance officer became concerned about Mr. Tanner’s financial ties to Philidor after Mr. Tanner sought approval to lease the pharmacy a property he owned. The request was rejected, the complaint said. The compliance officer later raised concerns with unnamed Valeant executives that Mr. Tanner had a financial interest in Philidor, the complaint said.

The complaint alleges that Mr. Tanner acted as a quasi-double agent for Philidor, using his role as a Valeant executive to discourage the company from doing business with other pharmacies. At the same time, the complaint alleges, Mr. Tanner privately counseled Mr. Davenport on how to negotiate better terms for an option agreement in December 2014 that required Valeant to pay about $300 million for the right to acquire Philidor.

Once a Wall Street darling, Valeant has been battered by an epidemic of problems including accounting issues, a brush with a potential debt default and investigations by Congress and federal regulators over drug prices. In a statement, the Canadian drugmaker pointed out its former CEO Michael Pearson, former CFO Howard Schiller, and current executives haven’t been charged.

Steve’s Take:

Two former executives–from Valeant Pharmaceuticals and its defunct pharmacy, Philidor–have been arrested and charged with committing fraud to personally enrich themselves.

We’re talking alleged kickbacks, some wire fraud, Travel Act Conspiracy. But what’s missing is any mention of anything that the Department of Justice has been investigating Valeant for, for over a year, says Linette Lopez for Business Insider.

And, more importantly, what’s missing from Thursday’s complaint suggests the end isn’t in sight. Not by a longshot.

Valeant has admitted, media have reported, and investors allege, that there was more to the Valeant/Philidor relationship than a quick, get-rich hustle. We’ve heard allegations of insurance fraud and price gouging, and lies about Valeant’s growth, for example. Philidor, according to these accounts, was at the bottom of all this.

According to the complaint filed in the Southern District of New York, Philidor CEO Andy Davenport and Gary Tanner, a former Valeant executive, colluded to ensure that Valeant would purchase a $100 million option to buy Philidor, which it did at the end of 2014. That purchase was not disclosed to investors and contributed to Valeant’s sudden, near-collapse last year.

Tanner, who worked at Valeant before leaving for Philidor in 2015, was promised a cut of what Valeant paid Davenport as the company’s relationship with Philidor grew, according to the complaint. He did not disclose to Valeant that he had a financial interest in the deal.

In a press release, Valeant said, “The company, former CEO, former CFO, and current executives have not been charged at this time.”

Underneath it, this face-saving, farcical statement is a transparent attempt by management to appear blameless in Valeant’s current morass. It’s way too late for that ploy.

Officials at the SDNY (Southern District of New York) have been investigating Valeant since at least October 2015. That’s when the company says it received subpoenas from the SDNY and state attorneys in Massachusetts. And this is what those investigators were looking for:

“The materials requested by those offices, pursuant to the subpoenas and follow-up requests, include documents with respect to the Company’s patient assistance programs (including financial support provided to patients); its former relationship with Philidor and other pharmacies; the Company’s accounting treatment for sales by specialty pharmacies; information provided to the Centers for Medicare and Medicaid Services; the Company’s pricing (including discounts and rebates), marketing and distribution of its products; the Company’s compliance program; and employee compensation.”

The arrests made on Thursday pertain to the alleged actions of two individuals to get money out of their customer, in Davenport’s case, or employer, in Tanner’s case, says Ms. Lopez. They are not about any shady activity going on at Philidor that Valeant may have known about–which is to say they are not about the pricing, marketing, compliance, or compensation issues that the SDNY has been looking into.

They also don’t address the alleged defrauding of insurers that the Wall Street Journal reported in August was part of the investigation.

Valeant investors such as TIAA-CREF (Teachers Insurance and Annuity Association of America–College Retirement Equities Fund) and T. Rowe Price are seeking answers to these questions themselves. They have, in lawsuits, accused Valeant of not only shirking its duty in failing to disclose the existence of Philidor, but also of engaging in fraud to get insurers to pay for expensive Valeant drugs when they normally would reject such payments.

Rejected payments are mentioned in the complaint against Davenport and Tanner. There, as in internal Valeant documents Business Insider viewed, they are referred to as “alternative fills.” They were a big problem for Valeant, and T. Rowe Price says executives at Valeant must have known about the “fraudulent scheme” Philidor was running to reduce their volume.

In its complaint, T. Rowe Price accuses Valeant of lying about its growth, its price-gouging practices, Philidor, its other “captive pharmacies,” its use of patient assistance programs to preserve high prices, the depth of its legal risk, and its lack of compliance and controls.

In a press conference after the arrests, Preet Bharara, US attorney for the SDNY, refused to discuss any continuing investigation into Philidor.

David Maris, an analyst at Wells Fargo, said after the press conference that he thought “additional charges against Valeant or former Valeant executives cannot be ruled out.” He added, “We left feeling that there could be more to come on this story, as it remains an active investigation with significant resources from multiple government agencies, including the district attorney’s office and the FBI.”

In its complaint, TIAA-CREF said Valeant and its executives actually conducted their due diligence into Philidor. “They visited the facility a bunch,” said the financial services firm, according to Ms. Lopez.

The case against Davenport and Tanner refers to site visits, too. In November 2013, Valeant executives visited Philidor’s offices, and at least one executive noticed that Tanner appeared to have an office inside Philidor, according to the complaint. Tanner led the tour of the Philidor facility, says Ms. Lopez.

That Valeant executives should visit the Philidor facility shouldn’t surprise anyone familiar with the Valeant story. Former CEO Michael Pearson held a tight grip on the company, says Lopez. It was his dominance, in part, that made the company a Wall Street high-flyer. Investors believed Pearson, a McKinsey graduate, had created an unbeatable business model.

The problem, these investors say, was that Pearson’s model was in large part dependent on fraud. Well, fraud’s the easy, default charge. I call it the three wise monkeys business management maxim, namely, see no evil, hear no evil, speak no evil.

“I find it difficult to believe that someone widely known as a control freak didn’t know anything about this,” said short-seller Andrew Left of Citron Research.

It was Left’s report on Valeant last year, along with stories from Roddy Boyd of the Southern Investigative Reporting Foundation that revealed Philidor’s existence to Wall Street. At the time, Left compared the company to Enron–the American energy giant that went bankrupt after short-sellers and reporters revealed that it was generating phantom revenue, simple accounting fraud.

In closing, here’s something insightful, I thought, compliments of the Wall Street Journal:

The Valeant employees were placed at Philidor while the pharmacy was in its infancy, to provide help on “structures and processes,” said a Philidor spokeswoman. She said in a statement that the Valeant employees set up separate Philidor email accounts, under “clearly distinguishable names,” to keep “their internal Philidor communications separate from the Valeant communications, primarily to reduce the risk of incorrectly sharing either company’s proprietary information.”

Of course that guarantees that the “fire-wall” separation between the two corporate entities was absolutely rock solid; impenetrable. Completely unsusceptible to inappropriate disclosures, cross contamination and, heaven forbid, “conflicts of interest.”

What’s there to question? Isn’t this the way it works everywhere?

No, it isn’t. It’s fantasy and testimony to how management brought the entire, snowballing mess largely upon itself. For Valeant, the very least we know is that things are not what they appear. Not even by employees using “clearly distinguishable names” for their roles at each of the two companies.

Steve's Take: Are @Valeant’s woes at the beginning of the end, or just the end of the beginning Click To Tweet

For you investors, is this the beginning of the end of Valeant’s woes, or just the end of the beginning?