Corporate Governance and the Imagination of Reality

This article was republished with permission from Tom Fox’s FCPA Compliance and Ethics Blog.

Legendary production designer Ken Adam died recently. If you are anything close to a James Bond aficionado, Adam is well known to you for his creation of the fabulous sets on movies from Dr. No to Moonraker. I still marvel at the early sets, and most especially one he designed for You Only Live Twice, for which he created a moon rocket launch port inside a false volcano. Adam’s work spans many, many other movies, including Barry Lyndon and The Madness of King George, for which his set designs won him two Oscars. He also created the war room in Dr. Strangelove. 

Christopher Frayling, writing in the Wall Street Journal, said of his friend, “In 1956 he wrote an article in which he argued that for him the point of art direction was to create an idea of place rather than a real place; he noted that he preferred a more theatrical approach that was closer to drama and storytelling than architecture, though it depended on an understanding of architecture. Much more interesting than merely imitating reality was creating a different kind of reality.”

It was the line “a different kind of reality” that struck me about corporate governance. Last fall, Valeant Pharmaceuticals International, Inc. (VRX) began its precipitous drop in value and in reputation when it disclosed it had perhaps too cozy a relationship with a third party, such that the company’s sales may have violated revenue recognition rules, invalidating the sales. This opened the company to an attack on its overall business model of purchasing other pharmaceutical companies, firing all the R&D staff and then jacking up the prices of long-term medications by as much as 5,000 percent. Of course these acquisitions were all fueled with huge debt packages, so the entire business model of the company may soon come crashing down.

Now both the Chief Executive Officer (CEO), J. Michael Pearson, and Chief Financial Officer (CFO), Howard B. Schiller, have left their posts in response to the precipitous stock drop, failure to make timely earnings forecasts and loss of confidence by the largely hedge fund investors who provided the debt for the company’s massive expansion. However, Valeant went a step further than even using the timeworn rogue employee defense to a Foreign Corrupt Practices Act (FCPA) violation when it blamed former CFO Schiller for providing incorrect information to the company’s auditors, which in turn led to erroneous filings with U.S. securities regulators. I guess they don’t have Andy Fastow to kick around about now.

Yet, in an uncharacteristic huff and puff, the CFO refused to resign his seat on the company’s Board and released a statement through his lawyers that said, “at no time did I ever provide any incorrect information to the audit and risk committee or to the company’s outside auditors regarding this accounting issue.” Making this story all the juicier (in a soap opera sort of way) is that from mid-December 2015 until early March 2016, when CEO Pearson was on leave due to sickness, the Board appointed CFO Schiller as the interim CEO. Certainly a different kind of reality is going on these days at VRX.

I also thought of Ken Adam’s different kind of reality when I read about the unsolicited bid by Chinese insurer Anbang Group to purchase the Starwood Hotel chain. It looked like Starwood was going to be purchased by Marriott for approximately $11.5 billion until Anbang came with a cash bid of a $13 billion, an offer about 15 percent higher than Marriott’s. Of course you might ask what experience a Chinese insurance company has in running a hotel? Not much, but it does have experience in buying hotels, as it bought the Waldorf Astoria in 2014 and recently bought Strategic Hotels and Resorts.

What do Anbang, VRX and Ken Adam’s perceived realities have to do with the compliance practitioner? Quite a bit, as it turns out. As noted by Steven Davidoff Solomon in his DealBook column, “Typically in a takeover battle, a strategic bidder should always triumph over a financial bidder like a private equity firm or Anbang, which has teamed up with two investment firms.” Since they have little or no experience, they tend to throw things around like VRX did in its never-ending growth strategies.

Moreover, if VRX was willing to push the envelope with its third-party partners, accounting practices, earning announcements and turmoil at the Board, what tone do you think that set for doing business in compliance with laws and regulations? It certainly sounds like compliance would not be up there as value No. 1 or even 1A (if you believe safety should be No. 1).

The same is true for Anbang and its bid for Starwood. Its debt-fueled acquisition strategy is seemingly predicated on Chinese ethics and investment strategy. If you load up on debt, where will the growth come from? Doing business ethically and in compliance? Where do you think that plays in a FCPA best practices compliance program? Right up there at the top? Perhaps in Ken Adam’s different kind of reality.

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