Valeant Pharmaceuticals: Ethical Evaluation Research Paper

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Abstract

Michael Pearson’s strategy to take over a pharmaceutical company, and increases its profitability by slashing down the budget for research and development was a red flag that people failed to notice. It demonstrated the CEO’s tendency to bend the rules for the sake of profits. The corporate leaders did not adhere to ethical principles that could have provided them a clear framework for their decision-making needs. Pearson and his team’s failure to utilize ethical frameworks for decision-making made them blind to the fact that their actions only benefited a few people while the same actions were detrimental to the lives of investors and various stakeholders. In order to prevent the occurrence of the same fraudulent scheme, it is important to enhance accounting standards so that it will not only react to the current situation because it also has the capacity to detect fraudulent schemes.

It is also imperative to develop higher standards when it comes to the accountability of corporate leaders in cases involving the deliberate act of deceiving investors with regards to the earning potential of the company. Finally, it is important to establish the correct environment that will encourage whistle-blowers to come forward and report the criminal or unethical practices within their respective firms. It must be pointed out that there are fraudulent schemes that are almost difficult to detect without the help of whistle-blowers.

Brief History of the Company

Strip away the outer covering of Valeant Pharmaceuticals and find a business enterprise that started its profit-making in the decade of the 1960s. One can argue that it started as an obscure organization focused on understanding the business side of the specialty chemical research enterprise. However, the company started to gain global attention at the turn of the 21st century when its corporate leaders initiated a series of mergers and acquisitions.

In the present time, the said pharmaceutical company sells a variety of drugs, such as over the counter medication and prescription drugs. The company’s radical assent into the top of Wall Street’s list of the favorable company started in earnest when it hired Michael Pearson as the new CEO of Valeant Pharmaceuticals. He orchestrated a series of major mergers and acquisitions that required the use of billions of dollars in resource allocation to take control of several companies. As a result, the company became one of the largest pharmaceuticals organizations in Canada. Although Pearson’s strategy made shareholders happy with the cash turnout, it can be argued that his method in acquiring and merging companies was done with a short-term view of the company’s future. The allegation of bending the rules to increase the profitability of the company in the present time was magnified when the new CEO decided to limit the resources that are funneled to Valeant’s research and development department. As a result, it boosted savings and enhanced the company’s cash flow position; however, it also jeopardized the company’s future.

After a few years as the CEO of Valeant, it seems like Pearson was not merely contented to make money using questionable means, such as endangering the future of the company in order to prop up the earning and savings of the organization. Allegations surfaced that the CEO was aware of the Enron-like fraudulent schemes to bolster the financial position of the company and attract investor’s money. In the beginning, the plan seemed to work, because as late as July of 2015, Valeant’s value was over $90 billion, a figure much greater than the valuation of some of the well-respected business organizations all over the world. Nonetheless, the company’s fortune started to tumble almost overnight. Recent estimates pegged the devaluation to as high as 50% of the original value.

Leading Up to the Ethical Dilemma

The eyes of the company’s shareholders and various stakeholders were glued on Valeant’s market valuation and stock price in the years leading up to the 2015 debacle. Many were giddy with excitement and failed to notice the tell-tale signs of the company’s demise into an ethical quandary that threatens to gobble it up into accounting scandals. Years before Congress issued directives for a full-blown investigation into Valeant’s activities, there were a few analysts questioning the prudence of Pearson’s decision to clamp down on a common practice of sowing back a good portion of the company’s profits to research and development.

Valeant’s modus operandi is to look for successful pharmaceutical companies with an impressive product portfolio and acquire the same through a hostile takeover. When the smoke clears, Valeant will initiate spending cuts in the research and development department. One of the primary purposes is to leave enough money in the bank to finance the next hostile takeover. A good example was Valeant’s attempt to take control of Allergan a company that is so successful it has tens of billions of dollars in market capitalization. Allergan spends at least 16% of its revenue on research and development, but in stark contrast, Valeant spends only 2.7 percent of its revenue on developing and improving its products (Katsanis, 2015). It is a good thing that Valeant failed to take over Allergan because the company’s executives were planning to slash at least $2.5 billion from its competitor’s research and development budget in the event that it succeeded in taking control of the rival group (Katsanis, 2015).

From the point of view of someone who is only interested in making money from Valeant’s conquest, the executive decision that drastically reduced funds for research and development can be considered a prudent action aimed at streamlining the operations of the company. However, those who had a deeper understanding of the inner-workings of the pharmaceutical industry saw the folly of the said strategy. It is unthinkable for companies like Apple, Sony, Phillips or even McDonald’s to slow down the release of funds for research and development. Innovation is the lifeblood of companies that look to dominate the industry that they are in, and Valeant is not that different from them. In fact, pharmaceutical companies have a greater responsibility to continually invest in research and development, because the business enterprise is dealing with drugs with side effects and other indirect causes. It is the duty of the corporate leaders from the pharmaceutical industry to continually strive for excellence in order to develop superior products that are effective and safe to use. Thus, Valeant’s refusal to use more than enough resources to provide high-quality products for their customers is a foreboding of things to come.

Impact of the Ethical Dilemma

The company started to unravel in September of 2015 on account of seemingly unrelated activity. Turing Pharmaceuticals decided to jack up the prices for one of its popular specialty type drugs. The steep increase in price caught the attention of legislators, and the brouhaha that ensured focused the spotlight on companies like Valeant. As the U.S. Congress decided to intensify its drive to transform the pharmaceutical industry, Valeant’s ethical issues started to come to the fore. One of the accusations that echoed through the halls of justice was the one that talks about Valeant’s Enron-like fraudulent schemes to enhance the value of the company from the point of view of investors.

According to a report from Citron a ten-year-old stock commentary website, Valeant acquired Philidor RX and exploited a loophole in order to bolster its revenue and made it appear as if it has found a way to significantly increase its profitability in recent years (Renick, Jackson, & Ciolli, 2015).

According to the report, Philidor is a specialty pharmacy that provides easy access to specialty drugs produced by companies like Valeant (Plunkett, 2008). It was discovered that Valeant acquired Philidor but did not disclose the said acquisition to various stakeholders. In a statement released by Andrew Left, Citron’s top researcher, Valeant’s control of Philidor placed the company in an ethical quandary, especially after Valeant’s inventory at Philidor was treated as part of the company’s revenue. It is indeed a legal loophole because before Valeant acquired the said specialty pharmacy company, it purchased its drugs from Valeant. Thus, for many years, Valeant’s earnings from the acquisition of drugs were reflected in the company’s books. Therefore, it was easy for Valeant to say that it committed a minor error in not disclosing the fact that Philidor is under its umbrella, therefore, it is illegal and unethical to declare that the drugs within Philidor’s inventory are computed as a part of Valeant’s revenue stream.

If there is evidence to support Andrew Left’s claim, Michael Pearson’s company will have a hard time defending itself from serious indiscretions, especially after Citron’s researcher declared that Valeant is the Enron of the pharmaceutical world. In other words, Valeant had the misfortune of being caught at a time when ethical standards were tightened after the Enron debacle less than 15 years ago (Fusaro & Miller, 2002). Furthermore, the Enron scandal has already created a bad precedent, therefore, there are fewer leniencies given to erring executives trying to exploit legal loopholes to increase the company’s stock market value and earning potential.

Enron utilized more complicated strategies to defraud investors and the general public. If the justice system’s highly attuned mechanisms for detecting fraud had been overhauled right after the Enron fiasco, there is little chance that Valeant will go through the investigation process unscathed. Valeant utilized simple duplicity tactics in the hopes that no one will notice that Philidor was already a component of the company’s business plan. Valeant’s risky strategy paled in comparison to the legal and ethical strategies that Enron employed to fool everyone. In the case of Enron, company executives used off-balance-sheet Financing and Fair-Value Accounting.

With regards to Off-Balance-Sheet Accounting, the money Enron paid in advance to energy companies was entered as income when the correct way to record the amount was to list it under the loans section of the company ledger. This practice was difficult to detect because a booming industry enabled the energy companies to repay Enron. As a result, it appeared as if Enron was making a great deal of money, however, there were not enough funds to keep the company afloat when a disaster strikes or when the energy companies are unable to repay the money they owed. With regards to fair-value accounting, Enron’s executives never operated under strict ethical standards, thus, they simply made valuations that benefited the company alone, but it was detrimental to investors and other stakeholders (Bryce, 2003). Andrew Left was therefore correct when he said that Valeant was using Enron-like tactics in creating in bolstering revenue figures using erroneous data.

Ethical Principles

If analysts will use utilitarian principles to help them determine the correct ethical decision, then, they will discover that Valeant’s duplicitous strategy to record inventory as part of earning was not an ethical way of doing business, because the action only benefited a few people. Only the corporate executives and a few other stakeholders benefited from the said action. Long-term investors were duped into believing that the company was earning a certain amount when in reality Valeant was earning a lower amount.

On the other hand, the utilization of Kantian ethical principles will compel analysts to look at the heart of the matter and determine the real intentions of the corporate leaders. In the course of the analysis, they will discover that the real intention of the leaders was to defraud the investors. According to the Kantian framework utilized to make ethical decisions, Valeant’s decision to cover up its ownership of Philidor was made to increase the value of the company by inflating its earnings data.

Using the virtue approach to analyze Valeant’s decision to confuse inventory with sales is an example of unethical behavior. According to the virtue approach in ethical decision-making, Valeant’s corporate leaders must perform actions that are based on the highest standards and geared towards the commission of great deeds. A cursory view of Valeant’s business practice, especially with regards to the Philidor fiasco revealed the human flaws of the leaders as they did not perform their duty as gatekeepers with regards to the investment funds entrusted to them by their respective investors. In other words, Valeant’s corporate leaders were not mindful of the company’s long-term growth, because they simply wanted to make money in the present time. The company was a mere tool in their desire to acquire more wealth.

Possible Actions: Prevention Strategies

Publicly traded companies and government regulators may focus on three major strategies to prevent a repeat of the Valeant-Philidor fiasco. These strategies are: 1) enhance accountings standards; 2) increase the accountability standards for corporate leaders; and 3) provide clear and compelling incentives that will encourage whistleblowers to come forward and report anomalies.

With regard to the first strategy, government regulators and other stakeholders must work together to enhance the accounting standards for publicly traded companies. Analysts and regulators must listen to an old adage from accounting experts who stated that the complex nature of the accounting process and the need to resolve conflicting approaches gives accountants the flexibility to present information in the best way that fits the objectives of the company. Thus, there are many opportunities for manipulations, deceit, and misrepresentation (Blake, 1998). Therefore, unscrupulous corporate leaders and accountants will always find a way to bend the rules. It is the responsibility of policymakers and regulators to determine the weaknesses in the system and to anticipate the strategies that unscrupulous people will use to gain advantage through the use of less than truthful ways of recording financial data.

The second major strategy is to enhance the accountability standards that regulators must use to examine the behavior of corporate leaders. Valeant’s CEO made an attempt to ridicule the findings of Citron. Even if it was clear as day that Valeant owned Philidor, and the drugs in their warehouses, the items that were not yet sold to their customers were already recorded as company earnings. Erring company executives will continually find ways to bend the rules, especially if they knew that they do not have to answer to their misdeeds. More importantly, they will brazenly attempt more complicated fraudulent schemes if regulators will not create a system of monitoring and detection that will lead to their public disgrace and criminal conviction.

The final piece of the puzzle is to create incentives for whistle-blowers so that they will find it beneficial to come forward and report anomalies that were committed within their own organization. It can be argued that this type of white-collar crime is difficult to detect. If not for the erudite analysis of Cintron, investors had no idea that Philidor was already under the control of Valeant. It would have been impossible for ordinary investors and stakeholders to understand how deceitful it was for Valeant to report earnings when in reality there was no sales transaction that occurred between the company and its prospective customers. In this type of complicated cover-ups and deliberate attempts to mislead regulators and monitors, sometimes the only way to detect fraudulent schemes is through the help of whistle-blowers.

Lessons Learned

It is best not to ignore tell-tale signs of unethical behavior. The decision of Valeant’s CEO to cut down on the use of resources for research and development was the first red flag with regards to the corporate leader’s decision-making framework. This action revealed that his primary concern was to increase the profitability of the company in the short-run, and he did not demonstrate any concern for the future well-being of the company.

Another insight that was gleaned from the study was the realization that accounting standards are only as good as the recently discovered scandals. In other words, accounting standards are reactive. It reacts to the discovery of unethical behavior from corporate leaders. However, it is difficult or almost impossible for accounting firms or third-party evaluators to predict how corporate leaders will design a new scheme to dupe investors.

The third major insight that was gleaned from the analysis of Valeant and Enron’s accounting scandal was the realization of the importance of whistle-blowers. More often than not, regulators and public watchdogs are dealing with highly capable and intelligent people who knew how to manipulate the system. For example, in the case of Enron, it took years before the fraudulent scheme was brought to the light of day. The presence of a whistle-blower willing to help investigators will speed up the process of exposing white-collar crimes. However, the government must provide clear incentives to encourage potential whistle-blowers to come out, and report the illegal and unethical activities within their own firms.

References

Blake, J. (1998). Ethical issues in accounting. New York: Routledge.

Bryce, R. (2003). Pipe dreams: Greed, ego, and the death of Enron. New York: Perseus Books.

Fusaro, P., & Miller, R. (2002). What went wrong at Enron. New Jersey: John Wiley & Sons.

Katsanis, L. (2015). Global issues in pharmaceutical marketing. New York: Routledge.

Plunkett, J. (2008). Plunkett’s biotech and genetics industry almanac 2009. Houston: Plunkett Research.

Renick, O., Jackson, A., & Ciolli, J. (2015). A question of revenue recognition. Web

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