Most people who follow financial news know about the mess that has befallen Valeant. A high flyer at one time, the stock hit a high of $263 in August 2015. Since then the stock has crashed to around $32. The stock slide has not been caused by general economic conditions, competition, or FDA pressures. Rather, it fell on its own sword…. so to speak.
I have been following the Valeant fiasco from a distance, as I have no financial interest in the company. What does interest me is why corporate governance has broken down to this magnitude in this company and unfortunately continues to break down in other public companies. Valeant stock has lost nearly 90% of its value due to the following:
- Questionable pricing strategies now being investigated by Congress;
- A hidden relationship with Philidor Rx Services that ultimately resulted in a related accounting misstatement causing previously filed SEC Form 10Ks and 10Qs to be unreliable, and delaying the filing of current financial reports; and,
- Abrupt changes to its guidance on 2016 revenue and EPS.
To make matters worse, the company and its executives are publicly playing the blame game with no one apparently responsible for all that is wrong. Here is the company’s official statement:
“The improper conduct of the company’s former chief financial officer and former corporate controller, which resulted in the provision of incorrect information to the (audit) committee and the company’s auditors, contributed to the misstatement of results. The company has determined that the tone at the top of the organization and the performance-based environment at the company, where challenging targets were set and achieving those targets was a key performance expectation, may have been contributing factors resulting in the company’s improper revenue recognition.”
First, the company is suggesting all of its problems are related to the accounting issues. As if a business strategy of buying old drugs and gouging consumers and their third party payers with incredible price increases, and forgoing drug research and development, is sustainable. Once they isolate the issue to accounting, they conveniently blame the CFO and Controller. In response, the CFO has publicly blamed the Controller. Therefore, we are supposed to believe the Controller is solely responsible for the company’s 90% drop in value!
Based on my 30 plus years in business I find this highly unlikely. I believe the company would have been more accurate and succinct by saying “the tone at the top of the organization was the key contributing factor relating to the company’s improper revenue recognition.” Throwing the CFO and Controller under the bus is classic scapegoating. The company’s reluctance to get to the truth and look for scapegoats is proof, in my view, that the tone at the top is the problem. The blather about performance targets being aggressive can be said of any company.
The tone at the top, by definition, is not driven by the CFO and Controller but rather the board and CEO. The Controller may have been overly aggressive in recognizing revenue and may have broken the accounting rules. If so, the finance department was likely under intense pressure to meet the financial goals set forth by the CEO and board. Accountants are often the messengers that are shot when the business results do not meet expectations.
Management would rather believe the accountants are too conservative or wrong than fix the business. In the beginning, the accountants can find some legitimate room for judgment to synchronize the books up with expectations. However, at some point, a line is crossed and nobody even realizes it until it blows up.
It takes strong resolve for accountants to stick with their professional judgment when the pressure from the top pushes for increasingly liberal accounting estimates. However, an entire series of blogs could be written on the failure of the accounting and auditing profession related to Valeant and similar situations. It is always amazing how trained CPAs can perpetrate material accounting mishaps that go undetected by both internal and external auditors.
Valeant will eventually replace the CEO, CFO, and Controller and this is certainly warranted. The board will be shaken up with the addition of William Ackman, whose hedge fund owns about 9% of Valeant. However, it seems to me when a company goes this bad; it is time for a new board of directors.
In addition, I would assume the audit committee, CEO and CFO have liability under Sarbanes-Oxley to ensure that a proper system of internal control was in place. Although an investigation is not yet complete, the public announcements to date suggest one or more material weaknesses in internal control existed. To prevent similar cases to that of Valeant in the future, individuals should be held personally accountable per the law. Until the CEO, CFO and audit committee members are held personally accountable for what may be interpreted as material misconduct, these situations will continue no matter what laws are passed. Bad characters give business a bad name.
As a former CEO and financial officer of financial services companies, I understand the need to be aggressive in the market. But I also believe CEO's must play straight and look out for the welfare of long term shareholders. Sustained success can only be achieved by selling enough product at fair prices people are willing to pay that result in sufficient profits to attract capital. A disciplined focus on revenue and margin growth through innovation and execution are the keys to success.
Our business at C-Level Partners is to help other businesses discover and execute on this formula. We would like to continue this dialogue and welcome any thoughts you have on Valeant, governance or how to achieve sustainable revenue and margin growth. Feel free to contact Dennis Drent at email@example.com or via phone at 714-290-3892.