The Unraveling Of Rhodia

France Inc. is under fire following the spectacular meltdown of the specialty-chemical company

Rhodiagate. That is what the French are calling the scandal enveloping Rhodia (RHA ), a Paris-based producer of specialty chemicals. The $7 billion company has lost $2.9 billion over the past four years and is struggling to pay down more than $3 billion in debt. The New York-traded share price has slid from more than $24 to less than $2 since it was spun off from French chemical-pharmaceutical giant Rhône-Poulenc in 1998. The French stock market regulator, in an administrative finding issued on Mar. 25, accused Rhodia of failing to disclose key information that could have warned investors of how dire things were. Rhodia says it is contesting the finding.

What's really shaking up France is that the meltdown happened under the noses of some of the country's most respected business and government leaders. Rhodia's board from 1998 to 2002 included Jean-René Fourtou, the former Rhône-Poulenc chief executive who was later brought in to restore financial health to media conglomerate Vivendi Universal (V ) after the disastrous reign of Jean-Marie Messier. Another Rhodia board member, and chairman of the board's audit committee during the same period, was Thierry Breton. He recently became France's Finance Minister after leading impressive turnarounds at France Télécom (FTE ) and consumer-electronics group Thomson (TMS ). Breton and Fourtou both say they were not aware of any improprieties during their tenure at Rhodia.

The travails of this chemical company lack the sex appeal of recent corporate scandals at Vivendi or at Crédit Lyonnais, the state-owned bank that was driven to the brink of collapse in the 1990s by reckless lending. But, says veteran French shareholders' rights activist Colette Neuville, who has represented aggrieved Rhodia shareholders since 2001, "Rhodia is the worst scandal we have seen. Vivendi and Crédit Lyonnais slid into disaster, but it wasn't premeditated. At Rhodia, things were arranged to deceive the market."

Rhodia, while declining to comment specifically on such criticisms, says it is defend- ing itself "vigorously" against lawsuits and investigations spurred by shareholder complaints. In interviews, several people with direct knowledge of Rhodia's operations described the complaints as ludicrous. "There was never any practice of hiding anything," says a Rhodia board member who, like others, asked not to be identified because of the pending investigations. Rhodia Chief Executive Jean-Pierre Clamadieu promises that the controversy will not derail a turnaround. "The future of this group depends not on the courts, but on our capacity to carry out our plans for recovery," he says.

"ROBBED BY ITS MOTHER"

Neuville and disgruntled Rhodia investors trace Rhodia's problems to another icon of France Inc. -- Rhône-Poulenc. They contend that Rhône-Poulenc used Rhodia as a dumping ground for hundreds of millions in environmental and pension liabilities and as a pawn to advance Rhône-Poulenc's own global ambitions. A year after spinning off Rhodia, Rhône-Poulenc merged with Germany's Hoechst to form pharmaceutical giant Aventis. Last year, Aventis merged with Paris-based Sanofi to become the global No. 3 drug company and a stock market favorite. "Rhodia was robbed by its mother," says Hughes de Lasteyrie, a Franco-Belgian businessman who says he has lost 90% of the $58 million he invested in Rhodia four years ago. Rhone-Poulenc's successor, Sanofi-Aventis, declines to comment on Lasteyrie's allegations and any others.

Rhodia itself has launched an arbitration proceeding against Sanofi-Aventis seeking $780 million to cover pension obligations and the expense of cleaning up chemical factory sites inherited from Rhône-Poulenc. But Rhodia is not alleging that Rhône-Poulenc concealed those liabilities, according to this board member and another person familiar with the case. Rather, Rhodia contends that unfore- seen factors, including weaker-than-expected returns on pension-fund investments and changes in environmental regulations, boosted liabilities beyond earlier forecasts. Rhodia has already received $114 million from Rhône-Poulenc and its successors to cover environmental liabilities. Sanofi-Aventis contends that it has fully met its obligations to Rhodia and should not have to pay more.

So far, Breton is the only present or former Rhodia board member to comment publicly about the case. In a statement issued by the Finance Ministry, he said that while on the board, "nothing that I learned shocked me or disturbed my sense of ethics." Yves Schmidt, a Paris lawyer who represents Fourtou and Igor Landau, both of whom served on Rhodia's board while working at Rhône-Poulenc and then Aventis, says disgruntled shareholders are wrong to suggest that the parent took unfair advantage of Rhodia. "Specialists and engineers reviewed all the holdings" at the time of Rhodia's spin-off, he says. "Maybe the experts were mistaken, but [Rhône-Poulenc executives] could not have known."

Meanwhile the legal storm appears to be gathering force. Last October, French magistrates opened a criminal investigation into alleged accounting irregularities and insider trading at Rhodia. The company says it does not want to comment on the probe because it has not yet been contacted by investigators. Separately, lawsuits have been filed by investors in France and the U.S., where Rhodia's American depositary receipts trade.

Even so, Rhodia only recently became headline news. One reason for the sudden interest was the appointment of former board member Breton as Finance Minister. Another was the murder in February of Edouard Stern, a prominent French investor who had waged a legal battle against Rhodia after he and his family lost more than $80 million they had invested in the company. However, there is no evidence linking Rhodia to Stern's death: Swiss authorities have charged his mistress with shooting him dead. On Apr. 21, a New York state court dismissed a lawsuit that the Stern family investment funds had filed against Rhodia and its directors on jurisdictional grounds, saying that the case did not belong in the U.S. courts.

So far, the legal maneuvering has produced few answers for Rhodia shareholders. France's stock market regulator, the Autorité des Marchés Financiers (AMF), while finding that the company provided investors with misleading and incomplete information, has not singled out individual managers or directors for blame. Jean-Pierre Tirouflet, who was Rhodia's CEO from 1998 through late 2003, the period when most of the alleged improprieties occurred, is now living in Austria. Tirouflet is unwilling to comment on the case but, like the company, is contesting the allegations made by the AMF and plaintiffs in pending lawsuits, according to his Paris-based lawyer, Jean Veil.

RISK EXPOSURE

More startling revelations could be in store. BusinessWeek has reviewed a report by the AMF staff that goes far beyond the publicly released allegations. The report, the culmination of an 18-month investigation, concludes that Rhodia deliberately misled investors about the first major deal it made as an independent company, its $1.1 billion acquisition of British chemical company Albright & Wilson PLC in spring 2000.

The Albright & Wilson case lies at the heart of shareholder assertions that Rhône-Poulenc took advantage of Rhodia. In 1999, when it began preparing a bid for Albright & Wilson, Rhodia was 67%-owned by Rhône-Poulenc and Rhône-Poulenc representatives held a majority of seats on Rhodia's board. Rhodia's then-Chief Executive Tirouflet had been an executive at Rhône-Poulenc.

While Rhône-Poulenc didn't object to Rhodia's bid for Albright & Wilson in principle, the timing was awkward. Rhône-Poulenc was preparing its merger with Hoechst, and if the debt required to carry out the acquisition was carried on Rhône-Poulenc's books, it could upset the balance of the planned "merger of equals" to create Aventis. To avoid this problem, Rhodia announced it had made a deal with Donauchem, a former Rhône-Poulenc subsidiary based in Austria, to set up an independent entity that would acquire Albright & Wilson. This entity, a British financial group called ISPG, would grant Rhodia an option to acquire Albright & Wilson a year later, by which time Rhône-Poulenc was expected to have sold off most of its Rhodia holdings.

The AMF staff called Rhodia's public description of the arrangement "inexact, deceptive, and insincere." While Rhodia said publicly that it had an option to buy Albright & Wilson at fair market value in spring 2000, investigators found that CEO Tirouflet had signed an agreement to make the acquisition at a predetermined fixed price. That, coupled with the fact that Rhodia had guaranteed debt issued by the Austrian company that financed nearly all the acquisition, effectively left Rhodia no exit from the proposed deal, the investigators said. If the AMF staff is right, then Rhodia -- and hence Rhône-Poulenc -- effectively owned Albright & Wilson in early 1999.

A Rhodia board member with detailed knowledge of the transaction vigorously disputes the AMF investigators' conclusions. He says that the agreed-upon fixed price in fact represented Albright & Wilson's fair market value, "since it was a price agreed to by an informed buyer and seller." Moreover, he says, Rhodia made no secret that it was guaranteeing most of the financing for the acquisition.

The AMF investigators' findings about the Albright & Wilson deal were not made public because the AMF's governing body decided not to pursue the case. Without explaining its rationale in detail, the governing body said that although the transaction had some unusual aspects to it, investors had enough information to understand generally what was taking place. Moreover, the governing body said a three-year statute of limitation precluded the agency from pursuing complaints about the transaction. However, a lawyer familiar with the case says that the staff findings could still be used as evidence in pending civil and criminal cases. The AMF declines to comment on its publicly released findings or on the staff report.

Did the Albright & Wilson deal hurt Rhodia financially? The evidence is inconclusive. Rhodia later sold a number of Albright & Wilson units, reaping more than $800 million on those sales. On the other hand, Rhodia has taken more than $160 million in write-downs, including pension-fund shortfalls inherited from Albright & Wilson, without specifying what portion came from the British company.

Certainly, such figures pale compared with Rhodia's broader woes. Hard-hit by higher fuel prices and weak demand, it has posted deep losses since 2001, while piling up debt for acquisitions, such as pharmaceutical ingredients maker ChiRex, that later performed poorly. By slashing costs, Clamadieu cut Rhodia's net losses to $811 million last year, half the 2003 figure, while selling assets to pare debt by 25%, to $3.1 billion. He predicts a return to profitability by 2006.

The legal fallout from Rhodiagate could continue long after that. The AMF proceeding, which could lead to a fine of up to $1.9 million for Rhodia if the initial findings are upheld, could wrap up in a few months. But Magistrates Henri Pons and Jean-Marie d'Huy, who opened a criminal probe in October, 2004, have said nothing about whether indictments might be handed down. Civil litigation is likely to move slowly, too. Will Rhodia's long-suffering shareholders find relief? Only slowly -- or maybe never.

By Carol Matlack in Paris

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