In 2003, what was then ICN Pharmaceuticals, Inc. changed its named to Valeant Pharmaceuticals, giving rise to what would become one of Walls Street’s strongest performers in subsequent years only to fall entangled in scandal, corruption, and suspicions of fraud and other unethical practices. Today, Valeant designs, develops, and markets a variety of generic and branded pharmaceuticals in addition to a portfolio of medical devices, such as contact lenses. Together, these products are marketed in some form in over 100 countries across the globe. Frequently listed in recent years as one of the most innovative and pioneering companies, the Canada-based drug company has developed a strategy of rapid mergers and acquisitions to increase its strength and scope as well as to leverage supply chain synergies and capabilities. Additionally, this aggressive dedication to acquisitions often involves buying the rights to competitors’ drugs and then quickly hiking the prices to increase profits and shareholder returns without making any changes to the drugs. As Valeant continued to grow and its stock price soared, the company collected up to thirty billions dollars worth of debt and faced staunch political and public opposition for its “price gouging” business strategy. Although many influential players in the modern pharmaceutical industry often adopt similar strategies, Valeant stands out for the amount and magnitude of its prices increases as well as research and development expenditures that are far below similar and competing drug companies. Yet, drug pricing is not the only reason Valeant has come under scrutiny in recent months; the drug manufacturer also faces allegations of accounting fraud, unethical partnerships, overbearing influence from activist investors, and tax evasion through inversion. J. Michael Pearson, Valeant’s CEO and former McKinsey veteran who joined the company in 2007 as a consultant and became CEO the following year, spearheaded the organization’s aggressive strategy and operations. After recently returning from medical leave, he has agreed—amidst serious pressure from the board—to step down once a replacement is found. In the following pages, each of these scandals surrounding Valeant will be discussed in detail in attempts to uncover the reasons behind its over 80% drop in stock price over the last year.
History of Notable Mergers and Acquisitions:
As mentioned, Valeant’s history has been defined by its relentless focus on acquisitions and slashing costs through reducing research and development spending as well as laying off many employees from these newly acquired firms. Most notably, in 2010, Valeant pharmaceuticals in California was acquired by Biovail and the two merged operations under the name Valeant, headed by Pearson. However, Biovail was a Canadian company, so this merger allowed Valeant to move its headquarters to Canada and, thus, receive a significant tax break from the inversion. This and similar corporate inversions remain highly controversial, especially considering the fact that Pearson works out of an office in New Jersey (Pierson 2015, 1-2). With its tax rate significantly lessened, Valeant became evermore focused on its acquisition strategy. Since this merger, Valeant has been among the most active acquisition-focused companies, with over thirty new transactions. In 2012, Valeant made a number of acquisitions in attempt to diversify its product offerings; the organization acquired dermatological drug company Medicis for $2.6 billion and Russian cold and cough pharmaceutical manufacturer Natur Produkt for $180 million. Another success story for Valeant is its acquisition of Bausch & Lomb, an eye care company, for the price of $8.7 billion, its largest deal to date. In 2015, Valeant made more significant moves in acquiring the gastrointestinal drug company Salix as well as the creator of the first women’s libido drug, Sprout. Still, despite these successful acquisitions, Valeant has faced a number of failed takeover attempts. These notably include failed merger talks with Activis and an unsuccessful $5.7 billion bid for biopharmaceutical company Cephalon (Alden 2014, 1-2). Although this series of rapid acquisitions and mergers undoubtedly proved beneficial for Valeant’s executives and shareholders, it created incredibly damaging effects for many workers. For example, Valeant disposed of 750 of Medicis’ 790 employees following the deal and 3,000 workers from Bausch & Lamb, a significant portion of which were U.S. jobs (Morgenson 2015, 4). This implacable dedication to acquiring other pharmaceutical companies and minimizing costs as opposed to investing in R&D in the development of its own proprietary drugs has exposed Valeant to failure as this business model focuses on the short term and is not sustainable for long term growth and success.
Influence from Activist Investors:
Activist investors are becoming increasingly common and influential in many industries and this often leads to concerns regarding conflict of interest and coercion to reliance on short term gains. Valeant has been criticized for the degree to which activist investors have influenced its operations over the years and this is best evidenced by the investment firm ValueAct and Bill Ackman’s popular hedge fund, Pershing Square Capital Management. ValueAct is a San Francisco based investment firm that is highly involved with Microsoft and has two seats on the organization’s board. Headed by Jeffrey Ubben, this firm was an investor in Valeant from its early stages (since 2006) and has remained quite influential in many of its operational and strategic decisions. In particular, ValueAct was the primary force behind the installation of J. Michael Pearson as CEO and oversaw the development of his compensation policy, which was directly tied to share performance and believed to be responsible for hyper aggressive and other abnormal accounting procedures in order to artificially inflate the short term stock price. Interestingly, ValueAct sold $1 billion worth of Valeant stock just a few months before scandal and accusations surrounded the company and its stock price began on a blistering descent to an 88% loss from its former peak. Although the firm claimed that this sudden selling of Valeant stock was not related to any impending troubles, it is difficult to imagine that it knew nothing about Valeant’s struggles considering the length of the relationship with Valeant and ValueAct’s presence on the company’s board. Although ValueAct may not be directly responsible for the day-to-day procedures and decisions at Valeant, they surely are at least partially responsible for endorsing Pearson as chief executive and aiding in the creation of some practices that ultimately contributed to Valeant’s controversy and decline (Sorkin 2016, 1-5).
Bill Ackman, unlike ValueAct, has received a large deal of public criticism for his seemingly unyielding support of Valeant, even going as far as to suggest that Valeant was the next Berkshire Hathaway. The partnership between Ackman and Valeant began in 2014 when the two joined forces in hopes of acquiring the pharmaceutical company Allergan, maker of Botox. The partnership is believed to have been motivated by William Doyle, an employee at Pershing Square who was very close friends with Pearson and a former classmate of Ackman’s. Initially, the partnership seemed an excellent match for both parties; Ackman received the hostile bidder he had been looking for to make a high-profile acquisition and Valeant gained a seasoned hedge fund manager with significant experience in the boardroom. Ackman’s firm, Pershing Square, began acquiring a significant stake in Allergan that would eventual amass to 9.7 percent voting power worth billions of dollars. Disappointingly, this hostile takeover attempt failed, which led to strain in the relationship between Pearson and Ackman (Gelles et al. 2014, 1-4) With his primary fund down over 25% so far this year, Ackman’s bet on Valeant has proven to be one of his biggest failures, leading him to publicly concede that this investment has damaged the reputation of his firm and that he paid far too much for his initial stake in Valeant. This once amicable relationship between Pearson and Ackman turned sour and Ackman was largely instrumental is ousting the CEO from Valeant. Today, Ackman holds a board seat at Valeant in an attempt to save the firm from further destruction and salvage his considerably large investment (Celarier 2016, 7-11).
Above: J Michael Pearson (left) and Bill Ackman (right)
Allegations of Accounting Fraud (Short Sellers):
In October of 2015, prominent short seller and chief of Citron Research, Andrew Left, released a report accusing Valeant of unethical accounting practices and likening the pharmaceutical company to Enron. The accusations are centered on an entity known as Philidor RX, a specialty pharmacy used by Valeant to help coax customers and doctors into using its branded drugs as opposed to other similar generics. Valeant had not previously disclosed its relationship with Philidor, until scrutiny surrounded the partnership and Pearson announced that Valeant and Philidor had consolidated their financials and Valeant had purchased an option to buy Philidor. Another company involved is R&O Pharmacy, who filed a suit against Valeant claiming that it received an invoice from Valeant worth $69 million for products it never received. What Citron believes to be the “smoking gun” in this case is that Philidor and R&O are actually the same company with identical management. Left alleges that Valeant orchestrated this network of pharmacies merely to create “phantom accounts” and fake invoices to deceive the auditors and to inflate revenues. Unlike Enron, Valeant is a legitimately profitable company, yet some of the accounting manipulations seem eerily familiar; Citron also noted the similarity between Pearson and Jeffrey Skilling in that they both came from McKinsey with no prior experience running a company. Although Valeant disavowed these allegations, its stock price nonetheless dropped some 40% following the report’s release (Lent 2015, 1-6). Valeant recently announced that it had improperly booked $58 million worth of revenue, a relatively small sum compared to its total operations, but this mistake creates skepticism of bigger problems. Two accounting methods believed to be employed by Valeant in order to inflate earnings and revenue include channel-stuffing and spring-loading. Channel-stuffing involves sending more product through a distribution channel than it is capable of selling, or offering other incentives to get distributors to sell its products. This is what Valeant was doing with Philidor as it booked sales of products that were sent to the specialty pharmacy but had not yet sold. Spring-loading is a problem that is created in the process of acquisitions; the acquirer of a company makes the costs of the acquired company appear higher and revenues lower during the interim period between the finalization of the deal and the date the two companies officially merge. Once the companies are officially combined, the costs and revenues return to normal levels, making profits for the acquiring firm appear higher. As Valeant has asked for an extension in reporting annual earnings, and a prominent creditor has just called for a default, the company faces serious uncertainty regarding its questionable accounting practices (Eavis 2016, 2-5).
Above: Andrew Left, prominent short seller and head of Citron Research
Controversial Drug Pricing Strategy:
At the heart of the controversy surrounding Valeant rests its high drug pricing strategy; this, along with distribution practices and patient assistance programs has sparked an investigation by federal prosecutors into Valeant’s proceedings. The process of buying competing drugs and then hiking prices before generic substitutes are available has become somewhat commonplace in the pharmaceutical industry today and has been notoriously publicized through Turing Pharmaceutical’s Martin Shkreli. Two such drugs include Valeant’s newly acquired Nitropress and Isuprel, two essential heart medications that saw price increases of 212% and 525%, respectively. While Valeant attempts to defend these price increases by arguing that the extra profit is necessary in funding R&D, Valeant’s R&D expenditure as a percentage of sales in 2014 was a mere 3%, compared to values well into the teens by other prominent multinational pharmaceuticals. Price hikes of these drugs—which occur without any medicinally valuable changes being made to them—have had damaging effects on hospitals and other health care providers. For example, the Cleveland Clinic was forced to add 7% to its budget due to the prices increases of these two cardiovascular drugs alone. Yet, Valeant’s price gouging strategy is not isolated to these two heart drugs, for which there are few quality alternatives; since 2011, Valeant has raised the prices of drugs by more than 20% over 120 times (Rockoff and Silverman 2015, 1-6). Further examples include Curprimine, a drug for Wilson disease whose prices more than quadrupled once owned by Valeant and Glutezma, a diabetes pill originated by Salix whose price was raised approximately 800% once Valeant gained ownership. On average, Valeant raised the price of its branded drugs 66%, which is close to five times more than other similar companies in the industry. These price increases have a trickle-down effect in that high prices lead to higher costs for hospitals and other health care providers, leading to more expensive premiums and copays paid by the consumer (Pollack and Tavernise 2015, 1-4).
Ethical Analysis: Valeant through the Lens of Deontology
Collectively, all of the circumstances described in the preceding pages concerning Valeant and its operations provide fruitful subject matter for a thorough ethical analysis. Deontology, which comes from the Greek word for “duty” is a field of ethics pioneered by Immanuel Kant that focuses on rules, obligations, and universalism in determining the moral character of a particular act. In contrast to utilitarianism, which is concerned with achieving the best possible net impact of an act (i.e. greatest happiness), in deontology, actions are judged independent of the outcomes. A morally wrong action may ultimately lead to a beneficial outcome. Kant believed that humans, and humans alone, possess the unique ability to think rationally and this is what allows humans to act according to duty and universal moral law. Kant and other deontologists believe that emotion ought to be removed from decision-making and that good will is the highest form of moral law and duty (Shakil 1-2). In considering the notion of duty and its centrality to deontology, it is important to ask the question to whom does Valeant’s primary duty and responsibility lie? Is it with shareholders and activist investors or the patients who benefit from and in many cases depend on Valeant’s products for survival? J. Michael Pearson, in Al Dunlap-like fashion, proclaims that as CEO his primary duty is to the shareholders. This, in his mind, legitimately justifies these price hikes and questionable accounting methods in that they ultimately lead to greater profit for the company and, thus, greater value and returns for the shareholders. Yet, this appears to underscore the fundamental notion that as humans, we ought to be responsible (i.e. have a duty) to aide and protect those who are dependent for survival. In this case, those dependent individuals are the millions of people who need Valeant’s drugs to survive. This is not to suggest that Valeant should become a charity, distributing drugs at little or no cost, but rather that it has a responsibility to provide for those customers who depend on its products while simultaneously generating a reasonable profit. Price hikes of up to 800% are categorically unjustifiable and far exceed the notion of a reasonable profit. Although not legally obligated, Valeant and similar pharmaceutical companies are ethically and morally obligated to provide affordable drugs to their customers and consumers. It is the formation of productive and mutually-beneficial relationships between corporations and clientele that leads to sustainable, long term growth, not short term objectives such as sudden price hikes and channel-stuffing.
Also critical to Kant’s theory of deontology is the notion of the categorical imperative. The categorical imperative is a duty that is absolute and unconditional and must be obeyed under any and all circumstances; thus, to all rational beings, it is binding and must be respected. Kant offered three primary formulations of the categorical imperative in order to more fully comprehend the idea. The first of these is, “act only on maxims which you can will to be universal laws of nature” (Bowie 1999, 4). This means that every action must be considered from a universal perspective. In other words, what would a world be like in which every company acted as Valeant did? This formulation of the categorical imperative suggests that Valeant’s actions are immoral in that if every pharmaceutical company were to raise prices to the extent of Valeant, consumers and health care providers would be paying incredibly high and most likely unaffordable costs. Beyond pharmaceuticals, if every corporation in the global economy raised the prices of its products to such unjustifiable levels and engaged in these sorts of hyper aggressive accounting practices, consumers and investors everywhere would be decimated. If other products that, like pharmaceuticals, are often necessary for an individual’s survival underwent the sorts of price increases seen in Valeant’s products, many would essentially be left without a viable method of survival. Furthermore, if every American corporation were to undergo corporate inversions, many Americans would be left without work and the government would experience a significant loss in corporate tax revenues. If Valeant’s strategies and operations were to become universally adopted, chances of long term growth and sustainability would be severely lessened by an exorbitant focus on short term returns. Although the moral objection that sudden price hikes employed by Valeant lead to an inequitable access to drugs is clear, a deeper analysis of the issue reveals that Valeant is not the only company acting in this manner. In fact, the company argues that price increases are standard industry practice and cites moderate increases by companies such as Pzifer as resulting in more damaging effects because drugs from these companies are sold in significantly larger volumes. So, maybe those pricing practices employed by Valeant are already somewhat universal, but Valeant is an extreme case. Thus, because the global economy would be negatively affected should every corporation adopt identical practices as Valeant, the company is acting in a way that is neither ethical nor morally permissible, according to deontology.
The second and third formulations of the categorical imperative are as follows: “always treat the humanity in a person as an end, and never as a mean merely” and “so act as if you were a member of an ideal kingdom of ends in which you were both subject and sovereign at the same time” (Bowie 1999, 4). Essentially, Kant’s second formulation means that one individual must not use another individual simply to satisfy their own desires and interests and that interactions with others should be designed to contribute to “rational and moral capacities.” With this formulation in mind, Valeant is quite clearly violating the necessary requirements in order for its tactics to be deemed ethical or moral. In acquiring companies and then quickly terminating large portions of its employees, Valeant is using other individuals strictly for its own financial benefit through increasing shareholder returns. Additionally, Valeant is using customers dependent on its drugs for financial gain and deliberately deceiving others through its complex and opaque network of specialty pharmacies. The third and final formulation of the categorical imperative provided by Kant recognizes that persons comprise organizations and, thus, organizations must be mindful and respectful to treat all with dignity and respect. Such a moral community would make decisions that consider the interests of all affected stakeholders (Bowie 1999, 10-11). It is not difficult to see that—although it might publicly act as a champion of all involved constituencies—Valeant is not giving equal consideration to users of its drugs and its shareholders. Moreover, because Valeant has benefitted greatly from the public and larger society, they in turn have a duty and obligation to reciprocate this generosity and beneficence. Without hospitals and pharmacies purchasing drugs and patients taking their daily medications, Valeant would have no sales and no profitability. The company is not representative of a moral community in that it fails to address the needs of all stakeholder groups which allow it to succeed and grow. Thus, in considering Kant’s second and third formulations of the categorical imperative, Valeant’s actions and strategies are not ethically justifiable.
As it has become evident, Valeant is an exemplar of many of the unethical activities present in the pharmaceutical industry today. With egregious price hikes that benefit it but hurt so many, excessive influence form activist investors, and other aggressive accounting methods, Valeant Pharmaceuticals is currently embroiled in scandal and controversy, but it is not yet doomed. The company still has an opportunity to elect new management and directors to save its reputation and profitability. Only time will expose whether Valeant will recover and continue to grow or become “the pharmaceutical Enron.”
Figure 1: Valeant’s stock price and notable company events
Figure 2: Proof that R&O and Philidor are the same company; taken from Citron report
Figure 3: Similarities between Skilling (Enron) and Pearson (Valeant); taken from Citron report
Figure 4: Graph of list prices of various drugs now owned by Valeant
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