It's bad, is the gist here.

Photographer: Spencer Platt/Getty Images

Valeant's Pharmacy Ties Get Even Murkier

Matt Levine is a Bloomberg View columnist. He was an editor of Dealbreaker, an investment banker at Goldman Sachs, a mergers and acquisitions lawyer at Wachtell, Lipton, Rosen & Katz and a clerk for the U.S. Court of Appeals for the Third Circuit.
Read More.
a | A

A while back I wrote about the relationship between Valeant Pharmaceuticals International, Inc., and its specialty pharmacy business, Philidor Rx Services LLC. I drew a simplified diagram of that relationship:

It turns out that the relationship was much hazier than I thought. There should have been ...  more squiggles? The squiggles should have come out of your computer screen and swerved around in three dimensions. They should have been red and pulsing. Today U.S. federal prosecutors brought criminal charges against former senior Valeant executive Gary Tanner and Philidor Chief Executive Officer Andrew Davenport, alleging that they built the Valeant/Philidor relationship, used it to enrich themselves, and concocted a whole mess of squiggles to conceal it from everyone else.

The gist of the complaint, signed by a Federal Bureau of Investigation agent, is this.  Tanner was the executive at Valeant in charge of "alternative fulfillment," a euphemistic-sounding program basically designed to get insurance companies to pay for branded Valeant drugs that they otherwise didn't want to pay for.  Typically the insurance companies didn't want to pay because the Valeant drugs were expensive and there were cheap generic alternatives available; if you just went to your local pharmacy with a prescription for a Valeant drug, it would fill it with a generic substitute. So "alternative fulfillment" involve giving patients and doctors incentives to insist on branded drugs, and working with "specialty pharmacies" that fill prescriptions with branded drugs and are good at convincing insurers to reimburse for them. Valeant worked with at least one "established, commercial health care provider" to do that work.

But -- says the complaint -- Tanner and Davenport had a better idea. (I mean: for them.) What if they set up their own specialty pharmacy, Philidor, and then sent all of Valeant's alternative-fulfillment business to themselves? Sure, that would not be great for Valeant: Using only one specialty pharmacy would increase Valeant's "payor risk," the risk that an insurer would decide to stop reimbursing Philidor.  And sure, Tanner, as a Valeant employee, was not technically allowed to own a stake in an outside pharmacy that did business with Valeant. But that's easy enough to get around: Davenport, the outsider, could run Philidor and own a chunk of it, while Tanner could be the inside man, making sure that Valeant sent business to Philidor and didn't use any competitors. "As alleged, while purporting to be arms-length business counterparts, the two men were, in fact, partners in crime," says U.S. Attorney Preet Bharara.

The only remaining problem was how Tanner could share in the profits he was creating, but that wasn't too hard either. After operating independently for a while, Philidor ended up more-or-less selling itself to Valeant for about $300 million in December 2014.  The complaint alleges that Tanner set the deal in motion by falsely claiming that Philidor was going to start doing business with Valeant's competitors, and then helped negotiate the deal in a way that pushed up the price. Of the $300 million in total cost, something like $133 million went to Philidor's shareholders. Of that, something like $40 million went to Davenport, who was a roughly 30 percent shareholder through a limited liability company called, appropriately, "End Game LLC." And of that, Davenport wired something like $10 million to Tanner, as, allegedly, a kickback.  

Also for some reason Tanner had an e-mail account at Philidor under the name "Brian Wilson." 

Now obviously you are not supposed to do this.  Everyone knows that. And Tanner and Davenport allegedly took some steps to cover it up. Tanner repeatedly certified to Valeant that he had no outside-business conflicts of interest. The alleged kickback to Tanner went through a series of shell companies, presumably to conceal its ultimate destination. There's that "Brian Wilson" e-mail account.

And yet Tanner couldn't quite help himself from showing off what he'd done:

In or about November 2013, Valeant Executive-1 and others visited Philidor's offices in Pennsylvania to learn more about Philidor's business operations. Valeant Executive-1 noticed that TANNER appeared to have an office inside Philidor, had access to Philidor's entire office facility, and acted as if he had a managerial role at Philidor by, for example, leading Valeant Executive-1 and others on a tour of Philidor's facility. This caused Valeant Executive-1 concern because TANNER was a Valeant employee, whom Valeant Executive-1 understood was providing advice to Philidor's sales team, but was not himself running the business.

The Valeant executive found it suspicious that Tanner walked around like he owned the place. (He sort of did!) So he mentioned his concerns:

As TANNER and Valeant Executive-1 were leaving Philidor, Valeant Executive-1 expressed concerns to TANNER about TANNER's level of control over Philidor and other issues. TANNER replied, in substance and in part, that TANNER knew Valeant Executive-1 would have these concerns and, for this reason, TANNER had hoped TANNER could delay Valeant Executive-1's visit to Philidor.

Wait, the executive confronted Tanner, and Tanner was like "ahh, you caught me, I knew this would happen"? That isn't good crime. Don't crime like that. Don't crime like this either:

DAVENPORT then forwarded TANNER's email to TANNER at the Tanner Brian Wilson Account, stating: "They are too deep in our shit. Can picture our butch and sundance ride into the sunset (or off the cliff as in the flick) as our wiggle room/ability to operate independently gets whittled down to nothing."

I actually have never seen "Butch Cassidy and the Sundance Kid," but I have watched a lot of "Scooby-Doo," and like everyone else I find it satisfying when the bad guys confess at the end and say "I would have gotten away with it too, if it wasn't for you meddling kids." But you don't usually see that in actual federal fraud complaints.

Anyway! All of this stuff is weird, but here's the weirdest part: We knew the weird stuff already. It has been widely known for a long time that Valeant employees were intimately involved in setting up Philidor, that they sometimes worked out of Philidor's office, and even that they used fake names and e-mail addresses while working at Philidor. Philidor acknowledged the set-up -- and the fake e-mails -- last year.  "Brian Wilson" was nothing out of the ordinary; other Valeant/Philidor double agents included "Peter Parker" and "Jack Reacher." Roddy Boyd and Andrew Left and John Hempton first wrote about Valeant's Philidor ties more than a year ago, and noted how secretive Valeant executives were about the relationships. (Valeant's own disclosures were not especially helpful.) And earlier this year, Valeant restated its financials to reflect the fact that before it acquired Philidor -- back when Philidor was "independent" -- it wasn't really independent, and so should have been accounted for as a subsidiary of Valeant. The facts that Valeant had a weirdly close relationship with a captive specialty pharmacy, that Valeant executives were weirdly secretive about the relationship, that Valeant acquired that pharmacy in a weird transaction, that Valeant employees also worked for the pharmacy under weird code names: all of that has been public for a long time.

It's just that everyone thought it meant that Valeant was up to something. There were conflicting theories about what it was. Andrew Left alleged channel-stuffing. John Hempton alleged insurance fraud. Roddy Boyd pointed out the unacknowledged importance of Philidor's "alternative fulfillment" approach to Valeant's business. The details weren't clear, but you could easily imagine some sort of story in which Valeant was doing something shady or half-shady or at least secret, and obfuscating it with complex deals and fake e-mail addresses. 

But the Justice Department's theory is different: Valeant was having something shady done to it. Philidor wasn't an instrument of accounting fraud or insurance fraud set up by Valeant; it was an instrument of wire fraud set up by a Valeant executive to rob Valeant. 

That is a simpler theory! It makes it much easier to put someone in prison, if that is what you want to do, and the Justice Department does. It makes more sense than a lot of the competing theories: Why put Valeant employees at Philidor under fake names unless it's because you don't want their bosses at Valeant to know about it? 

It feels incomplete, though. The FBI has arrested "Brian Wilson," but "Peter Parker" and "Jack Reacher" and various other spies and superheroes are still at large. What were they doing at both Valeant and Philidor? It's one thing for Valeant management not to know that one of its executives was living a double life at one of its suppliers. But how could it miss a whole squad of Valeant employees doing that? And in fact Valeant executives began to catch on to the issue in November 2013 -- after Tanner led them on a tour of Philidor -- and started asking questions. But Tanner stuck around. A year later, Valeant paid hundreds of millions of dollars for Philidor. A year after that, journalists and short sellers started asking questions about the Philidor relationship -- and rather than slap their foreheads and shout "we've been had!," Valeant executives explained that the relationship was perfectly normal and ethical. And a year after that, Valeant turns out to be the victim of a fraud. It does seem like there might have been something in the culture at Valeant -- growth-hungry, sales-focused, acquisition-driven -- that allowed this sort of thing to flourish. Valeant may have been the victim here, but that doesn't necessarily mean it was completely innocent.

  1. By the way, if you had a bet that the Valeant scandal would bring criminal charges before the Theranos one, congratulations, you can collect your winnings!

  2. These are just allegations. Neither Tanner's lawyer nor Davenport's spokesman responded to Bloomberg News's requests for comment. Valeant put out this statement:

    Valeant Pharmaceuticals International, Inc. (NYSE: VRX and TSX: VRX) ("Valeant") today learned that a criminal complaint was filed in relation to Philidor. Gary Tanner and Andrew Davenport were charged in the matter. The company, former CEO, former CFO, and current executives have not been charged at this time. Gary Tanner ceased to be a Valeant employee on September 13, 2015, and Andrew Davenport has never been an employee of the Company. The counts issued today include allegations that the charged parties engaged in actions to defraud Valeant as a company. Valeant continues to cooperate with all relevant authorities in this matter.

  3. Tanner had previously done this job at Medicis Pharmaceutical Corp., which Valeant acquired in 2012. Here's how the complaint describes it:

    While working at Medicis, GARRY TANNER, the defendant, was in charge of what was known as Medicis's "alternative fulfillment" ("AF") program. Medicis's AF program was developed for pharmaceuticals that experienced low rates of insurance coverage because of their cost or the availability of generic substitutes. The AF program attempted to cause patients to take their prescriptions for such Medicis drugs to certain specialty pharmacies that would assist patients and doctors in obtaining insurance coverage for those drugs or would provide other incentives for patients to purchase Medicis-branded drugs instead of generic substitutes.

  4. For instance, with "patient access" programs that give patients coupons for reduced or waived co-pays. The patient ends up paying less for the branded drug than for the generic. The insurer pays much, much more. 

  5. Presumably payor risk is why Philidor ended up doing the downstream squiggles, acquiring control over Isolani LLC and R&O Pharmacy LLC, and developing other relationships. As Bloomberg News reported last year:

    Philidor Rx Services LLC, which fills prescriptions for Valeant Pharmaceuticals International Inc., instructed employees to submit claims under different pharmacy identification numbers if an insurer rejected Philidor’s claim -- to essentially shop around for one that would be accepted.

    Employees were to first submit paperwork with Philidor’s national provider identifier, or NPI, and if that didn’t work were to then try with the NPIs of partner pharmacies, according to a Philidor training manual.  “We have a couple of different ‘back door’ approaches to receive payment from the insurance company,” said the manual, dated October 2014.

  6. Technically, Valeant acquired an option to buy Philidor. In exchange, Valeant paid $100 million up-front, agreed to make several more milestone payments based on future sales, and agreed to forgive some debt. "In all, Valeant's auditors concluded that the cost to Valeant of the Philidor acquisition approached $300 million." But apparently only $133 million of this -- the $100 million option premium and the first $33 million milestone payment -- actually went directly to Philidor's equity holders.

  7. The complaint says that "On or about August 1, 2014, TANNER sent an email to Valeant Executive-3 asserting that one of Valeant's competitors wanted to do business with Philidor," and that "According to public disclosures made by Valeant concerning Philidor in 2015, Valeant ultimately decided it needed to acquire Philidor at least in part because it was concerned that Philidor would begin doing business with Valeant's competitors, thereby reducing Valeant's ability to use Philidor to achieve its objectives." But: 

    Based on my review of Philidor documents and interviews of Valeant and Philidor employees, I have found no evidence that any such interest was expressed by Valeant's competitors, nor that Philidor had developed any specific business plans to do business with Valeant's competitors.

    Tanner was not directly involved in negotiating the deal, but he gave Davenport advice on how to get a higher price, and, "as Valeant's subject matter expert on Philidor," he did consult with the executive in charge of negotiating the deal -- and told him that Davenport's financial analysis seemed fair and that he shouldn't worry too much about due diligence. 

  8. Pages 22-23 of the complaint have the details. Of course it wouldn't be a fraud case without a quick summary of the use of proceeds:

    Amon gother things, DAVENPORT withdrew $500,000 in cash; purchased over $20 million in securities managed by UBS; spent over $200,000 on a mortgage on an existing home and the purchase of what I believe is an additional home; and paid approximately $50,000 toward the installation of a custom wine cellar.

    Sounds nice! Tanner's alleged use of his smaller cut was more modest; he "made a payment of approximately $22,583 towards student loans and a payment of approximately $3,705.92 towards a credit card."

  9. It's a little interesting to ask why not. This is (allegedly) a crime called "honest services wire fraud," in which a corporate executive (Tanner) deprives his company of its "right to honest services" by acting against the corporation's interests in exchange for a bribe. For a while, this law was much broader, and all sorts of self-interested executive activity could be considered "honest services wire fraud." But the Supreme Court, in reviewing the case of former Enron Corp. Chief Executive Officer Jeff Skilling, "pared it down to what the majority called its 'solid core': the law may be used only to prosecute bribery or kickbacks."

    I assume a concealed $10 million kickback counts, though.

  10. After this, "Valeant removed TANNER from Philidor's offices for a period of time," but that was the only consequence. The executive asked Tanner if he owned any equity in Philidor, and Tanner denied it. "The Chief Compliance Officer also had concerns that TANNER might have a financial interest in Philidor," and raised those concerns to other executives, but nothing seems to have happened.

  11. From 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.” 

    Sure! Happens all the time! 

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author of this story:
Matt Levine at mlevine51@bloomberg.net

To contact the editor responsible for this story:
James Greiff at jgreiff@bloomberg.net