0. Francine McKenna, Transparency Reporter
The Challenge of Reporting on Pharma Company Fraud: Valeant Pharmaceuticals and Martin Shkreli
Francine McKenna, Transparency Reporter
for MarketWatch, a Dow Jones company
Washington DC
Georgia Southern Fraud and Forensic
Accounting Education Conference
Jekyll Island, Georgia
May 16, 2016

1. Agenda Two Cases: Valeant Pharmaceuticals Intl and Martin Shkreli
Allegations, Auditors, Investigations, Oh My!
Stocks Drop, Lawsuits Happen
Here Comes The Judge
What’s Next

2. Intro to two related cases: Valeant Pharmaceuticals Intl and Martin Shkreli
Drug pricing put them in the spotlight Larger than life personalities put them on the defense

3. Allegations, Auditors, Investigations, Oh My!
“If accounting scandals no longer dominate headlines as they did when Enron and WorldCom imploded in , that is not because they have vanished but because they have become routine.”
Dan Rosenheck, The Economist, “The Dozy Watchdogs”

4. Who is Martin Shkreli?
Shkreli was born in April, He grew up in Brooklyn. His parents are immigrants from Albania and Croatia.
At16, Shkreli dropped out of the prestigious Hunter high school in New York.
He interned for Cramer, Berkowitz & Co., founded by CNBC's "Mad Money" host Jim Cramer (Cramer had left his namesake hedge fund by then).
Shkreli's first run-in with the law took place in He told Cramer's fund to short a biotechnology stock, according to an interview with Bloomberg. Sure enough, the stock fell, and Cramer's fund profited. Shkreli was investigated by the SEC for the well-timed bet, but ultimately cleared of any wrongdoing.
He received a business degree from New York's Baruch College in 2004 and later worked at UBS and Intrepid Capital Management.
He founded a hedge fund called MSMB Capital Management. He made a name for himself by shorting biotech stocks and berating those companies on social media.
Shkreli founded Retrophin, a pharmaceutical company Feburary 2011.
That same month, Shkreli made a really bad bet shorting a biotech company called Orexigen Therapeutics. He lost $7 million for his hedge fund. He suffered $1 million in other trading losses too. With under $60,000 of assets left, MSMB halted all trading.
Shkreli continued to send investors progress reports about MSMB Capital as if the company were still a healthy company, according to federal prosecutors in an indictment in December.
Federal prosecutors say that between February 2011 and September 2014, Shkreli and an associate funneled money out of Retrophin to pay off debts owed by MSMB and by Shkreli, personally.
Source CNN

5. Who is Martin Shkreli?
In December 2012, Shkreli made a series of fake, backdated transactions to make it look like MSMB Capital had invested in Retrophin, the FBI says.
Forbes named Shkreli to its "30 under 30" in finance list.
Retrophin investors began to catch on, and seven demanded money from Shkreli. Between February 2013 and March 2014, Shkreli forced Retrophin to settle with the investors for $11 million, but he didn't ask the board's approval, according to the prosecutors.
In August 2013, Retrophin's auditor questioned the settlements, determining that they weren't the company's responsibility. Yet Shkreli continued the settlements, which he disguised from the auditor in the form of sham "consulting" agreements.
Retrophin's board voted Shkreli out as CEO in September 2014.
Shkreli formed Turing Pharmaceuticals in February 2015, which bought the rights to market Daraprim, a toxoplasmosis treatment used by AIDS patients.
In August 2015, Retrophin sued Shkreli for $65 million, saying he used the company's assets to pay off hedge fund investors.
Turing caught fire in September for hiking the price of Daraprim. A single pill, which had cost $13, was raised 5,000% to $750.
In November 2015, Shkreli bought KaloBios Pharmaceuticals. The company owned the rights to a drug called Benznidazole, which is used to treat Chagas disease. Shkreli said that KaloBios is planning to raise the price of the drug once the treatment receives approval from the FDA. Shares of KaloBios soared 400% after Shkreli bought the company. That same month, Turing cut the price of Daraprim by half for hospitals.
The U.S. Senate Special Committee on Aging opened an investigation of Turing in November.
In December, Shkreli announced that he was the mysterious buyer of the Wu-Tang Clan's newest album, "Once Upon a Time in Shaolin." The rap group had released just one copy of its album, putting it up for auction. Shkreli paid $2 million for it.
Shkreli was arrested in December for securities fraud. His lawyer said Shkreli "strongly denies the charges," and posted $5 million in bail.
Shkreli officially stepped down as CEO of Turing. Afterward, he took to YouTube and live streamed himself for nearly five hours.
Shares of KaloBios (KBIO) plummeted 50% following his arrest, and trading was halted all day.
On Twitter Shkreli proclaimed his innocence, saying, "I am confident I will prevail.”
Source CNN

6. Valeant Timeline
August 14: Senator, and presidential hopeful, Bernie Sanders and Congressman Elijah Cummings request information on why the company aggressively raised the price of two heart drugs.
September 28: Investigation of Valeant’s drug price strategy grows as 18 Democratic leaders call for a subpoena of the company. Outrage of drug price increases had been stirred by a New York Times story of a former hedge fund manager turned drug company CEO who hiked a drug used by AIDS patients by nearly 5500% overnight. Shares of Valeant fall 16%.
October 5: Study by Deutsche Bank analyst finds that it’s not just two drugs. The report concludes that Valeant has jacked up prices on 54 other meds this year alone by an average of 66%, far more than the rest of the drug industry.
October 6: Hedge fund Bill Ackman, and one of the Valeant’s largest shareholders, defends the drug company’s strategy saying it does a lot more to spur research and development than most people give the company credit for. The defense doesn’t make a lot of sense, and it falls on deaf ears.
October 14: Valeant confirms that it has received federal subpoena over its drug pricing strategy.
October 15: Australian hedge fund manager John Hempton, who has long questioned Valeant’s accounting, is the first one to utter publicly utter the word Philidor. But Hempton’s cryptic post, written like a scene out of The Graduate, offers no clues as what Philidor is, or that it is connected to Valeant.
October 19: On an earnings call with analysts, Valeant CEO Pearson says the company will ease up on its strategy of buying up drugs it thinks are mispriced and hiking prices. Also that day, a story from the Southern Investigative Reporting Foundation is the first to detail the odd ties between Valeant and Philidor, a rapidly growing specialty pharmacy that appears to be controlled by Valeant, but had never been disclosed to Valeant shareholders. The story says that R & O Pharmacy, an affiliate of Philidor, has sued Valeant saying it believes the drug giant may be the target of fraud or engaged in fraud itself.
October 20: A report by Citron Research, run by activist short-seller Andrew Left (who is actively shorting Valeant), reveals more information about Philidor and it’s network “of phantom captive pharmacies.” Left accuses the company of accounting fraud, and compares it to Enron.
October 22: Valeant calls Left’s report erroneous. The company says it hasn’t used Philidor to book fake salesPhilidor is a separate company, but that Philidor’s financials consolidated. Valeant says it has purchased an option to buy the company. Valeant’s shares have now plunged 30% in three days. Left calls Valeant’s relationship with Philidor the “turd in the punchbowl.”
October 26: An investigation by the Wall Street Journal finds that Valeant employees were frequently involved with the operations at Philidor, and used fake aliases including those of comic book characters, like Peter Parker, to hide their identity. On Valeant’s conference call, the company discloses for the first time that it paid Philidor $100 million to buy the company. But it maintains that the operations of the two companies are separate. Forming a special committee of the board to investigating its relationship with Philidor. Still, the conference call is unable to boost Valeant’s stock and leaves plenty of questions unanswered.
October 30: Valeant says it is cutting its ties to Philidor, and that the pharmacy will shut down immediatelyAckman holds a four-hour conference call to defend the company Valeant’s shares fall another 16%.
Dec 15, 2015: Valeant inks a deal to distribute its drugs through pharmacy chain Walgreens Boots Alliance.
Dec 16, 2015: The Canadian drugmaker says its Q4 profit was hit when it cut ties with pharmacy Philidor Rx Services, but it could contain the damage in 2016 and grow profit.
Dec 28, 2015: Valeant appoints group of company executives to take over duties of its Chief Executive Michael Pearson until he returns from medical leave.

7. Valeant Timeline
Jan 6, 2016: The company appoints former CFO Howard Schiller as interim CEO.
Jan 28, 2016: Hillary Clinton posts a blog detailing exorbitant price hikes for a VRX migraine drug Feb 4, 2016: U.S. congressional hearing with interim CEO Schiller
Feb 22, 2016: Valeant says it would restate its financial results for 2014 and 2015 after identifying some sales of Philidor that should have been recognized when products were dispensed to patients.
Feb 29, 2016: Valeant discloses that it is under investigation by the SEC a day after announcing the return of CEO Pearson from medical leave and withdrawing 2016 guidance.
March 1, 2016: Bill Ackman, who bought more shares of Valeant in late 2015, goes on CNBC to say that everything will be just fine at the company.  
March 7, 2016: Valeant says it would release preliminary quarterly results and guidance on March 15, two week after it was originally scheduled to be released.
March 8, 2016: Bill Ackman, a week after saying everything was just fine at Valeant, tells an investor conference that the company may soon need new management.
Mar 9, 2016: The company adds a representative from shareholder Pershing Square Capital Management to its board as well as two other new directors.
Mar 10, 2016: A U.S. congressional committee accuses Valeant of withholding documents.
Mar 15, 2016: Valeant cuts 2016 revenue forecast by about 12 percent and says a delay in filing its annual report could mean a debt default, causing its shares to plunge.
March 17, 2016: S&P says it is putting the debt of Bill Ackman’s publicly traded investment vehicle on review because of his Valeant losses.
March 18, 2016: CEO Pearson sends a memo to his staff reassuring them that the company will not go bankrupt. The price of Valeant’s debt had fallen to 76 cents on the dollar, roughly meaning that investors believed there was a 24% chance the company would not be able to pay back it’s creditors
Source Fortune Magazine

8. Allegations, Auditors, Investigations, Oh My!
Are auditors supposed to find fraud?
“In popular imagination, auditors are there to sniff out fraud.”
Dan Rosenheck, The Economist, “The Dozy Watchdogs”

9. Why Such a Challenge To Report?
Non-stop news
Complexity of accounting issues
Larger than life personalities
Lots of interest by media and others
Day of Valeant Citron report I was in NYC in WSJ newsroom
Multiple potential sources of news
Ackman, Value Act, Sequoia meant the interest in Valeant was at defcon 12
Difficulty in getting comments

10. Allegations, Auditors, Investigations, Oh My!
The Watchdog Hierarchy
(Think about the “client” each serves.)
Policies, procedures, processes and the internal controls governing transactions and processes
Internal audit
Executive leadership
Board of Directors
Audit Committee and Ad-Hoc or independent investigative committee
External Auditors
Regulators

11. Allegations, Auditors, Investigations, Oh My!
Allegations of accounting fraud
Shkreli and Retrophin
Audited by Marcum, then BDO
KaloBios
Audited by EY then Marcum
“Martin Shkreli hired same audit firm for KaloBios used at Retrophin”
Valeant Pharmaceuticals
Audited by PwC
Ackman had strongly criticized PwC re: his HLF short but conciliatory with firm re: Valeant
Short seller accusations (Citron, Hempton, SIRF)
Other news reports

12. Allegations, Auditors, Investigations, Oh My!
SOx signed into law after accounting frauds and scandals at turn of millennium in particular at Enron, WorldCom, Health South, and Tyco.
SOx requires companies to establish internal over financial reporting that can be tested and certified by management and then external auditors. Section 404
External auditors are required to flag any “material weaknesses” in a company’s internal controls, presumably providing an early warning to companies, investors and the SEC.
CEOs and CFOs must personally “certify” financial statements, risking civil and even criminal penalties if they knowingly sign off on bogus numbers. Section 302 and 906
Lying to the auditors can result in prosecution but rarely does. Section 303
Restatements may result in CEO/CFO bonus clawbacks. Section 304. Dodd-Frank rule pending approval.

13. Allegations, Auditors, Investigations, Oh My!
What are the external auditor’s tools for identifying, mitigating, warning of risk of errors and misstatements from fraud related to excessive risk-taking:
Assessment of risk of material misstatement due to error or fraud during planning and execution of the audit.
Assessment of internal controls over financial reporting including entity level controls such as tone-at-the-top and Identification of weaknesses - SOx 404.
Issuance of a going concern warning. (Not a qualified opinion just an emphasis of matter.).
Qualified, adverse or disclaimer of opinion. Auditor can also resign. (Audit Analytics says no Big 4 auditor has given an S&P 500 company anything other than a non-qualified opinion. Auditors that resign are sued.) Could Valeant’s auditor resign? Chances are slim but not none

14. Allegations, Auditors, Investigations, Oh My!
Cue the internal investigations
Retrophin
Valeant
Forensic accounting firm never disclosed by company but Ackman reveals it on a call and says more than once work done by PwC and Deloitte should restore confidence.
Deloitte has done extensive consulting work for Valeant on pricing strategy and Schiller quotes Deloitte in his Congressional testimony.
“Valeant must untangle web of allegations on Monday call”
“Valeant’s newest disclosure — the $100 million option to buy a company for nothing”
“Valeant uses rare accounting maneuver for acquisitions that cushions income”
“What Valeant and its auditor must do before finalizing 2015 numbers”
“Valeant makes small dent in long list of issues raised”
“Valeant still isn’t finished with work to resolve accounting issues”
“Valeant investigation finished without a written report”
Federal, state and industry investigations of fraud and antitrust
Congressional inquiries and subpoenas “Democrats call for subpoena of Valeant's Pearson and Turing's Shkreli”
“Martin Shkreli subpoenaed by congressional committee” “Shkreli tweet suggests he may not testify”

15. Stocks Drop, Lawsuits Happen
Valeant’s stock down more than 90 % in the last 12 months
Valeant fought off bankruptcy before finally issuing delayed 10-K“Valeant struggling to stay ahead of creditors given ongoing filing delay
”Valeant may get bank waivers but risks default with SEC and NYSE” “Valeant’s stock rockets to best two-day gain in 20 years”

16. Here Comes The Judge Plaintiffs lawsuits pending
Martin Shkreli and his lawyer Evan Greebel are facing civil and criminal charges

17. What’s Next New Leadership Lawsuits
Valeant
“One thing Ackman’s right about — drug companies survive billions in fines”
“Ackman’s testimony suggests he’s in charge at Valeant”
Shkrei’s former companies
KaloBios fired Shkreli after his arrest December 17. He had bought a controlling stake less than a month before. Filed Chap 11 Dec 30.
Retrophin sued Shkreli in August Shkreli had left the company in a cloud in October Company settled with investors over allegations that are basis for their suit against Shkreli and now part of DOJ/SEC charges against Shkreli.
Turing’s Daraprim, a treatment for AIDS was instigator of the drug pricing scrutiny. Founded by Shkreli with patents he bought from Retrophin. He resigned after arrest.
Lawsuits
For now no auditors have been sued
Trial or pleas (Shkreli and Greebel)
Clawbacks
Valeant’s Pearson and Schiller

18. Francine McKenna
Transparency Reporter, MarketWatch, a Dow Jones Company
Washington DC
re: The Auditors
Founder and Editor
Previously featured at:
Accounting Watchdog at Forbes.com
Former Columnist and magazine contributor
Accountable at American Banker
Former Columnist
Bull Market at Medium.com
Former Contributor
The University of Chicago Booth School of Business Capital Ideas Blog
LinkedIn: