Valeant Pharmaceuticals International (NYSE: VRX) (Valeant) was recently the subject of a research report by Citron that alleged the company was the pharmaceutical Enron. The best summary is here by Bronte Capital. The stock price has collapsed and allegations continue to fly. Interestingly, the allegations swirling around Valeant relate to the accounting rule that was created to stop the abuses exploited by Enron – the variable interest entity (VIE).
Citron alleged that Valeant had a network of phantom pharmacies operated by Philidor. Valeant had an undisclosed option to purchase Philidor and consolidated the financial statements of Philidor on the basis that it was a VIE but did not disclose this accounting because the operations were deemed immaterial at 7% of sales. Citron alleged channel stuffing at the phantom pharmacies. Valeant stated that consolidation meant that sales to the VIEs could not be recognized until there was a sale to an outside customer. Valeant’s explanation of the accounting seems plausible, although I question whether the argument that VIE disclosures can be omitted at that level of materiality is correct.
NEEQ has listed 3,365 companies since 2013. The 3,751 listed companies are mostly microcaps. Listing on the NEEQ is easy. Unlike China’s exchanges, there are no requirements that the companies be profitable or growing. China’s security regulator has little involvement and local CPA firms typically audit the listed companies.
Sound familiar? Yes, it appears to be a Chinese version of the reverse merger technique used by many companies to quickly list in the United States. That technique collapsed in wave of fraud. The problem with many reverse mergers was that the market was that poorly regulated and unscrupulous promoters and advisors took advantage of the lack of regulation to perpetrate frauds on the market. There is a big difference, however. US regulators could not investigate or punish fraudsters located in China. Chinese regulators can.