Irish pharmaceuticals group Elan Corp. decided to open its books to clarify an opaque accounting system that used off-balance-sheet vehicles, and has been rewarded with no fewer than 10 class action lawsuits filed by U.S. investors in the space of a week. In addition, late last week, the Securities and Exchange Commission began investigating allegations that the company engaged in deceptive accounting practices.
This is not the first time the firm’s accounting practices have come under scrutiny, but the mention of two terms ensured that this time it would make front-page news. “People hear off balance sheet’ and joint ventures’ and think Enron’,” said Arthur Wong, an associate director in Standard & Poor’s corporate ratings group. But in Elan’s case, these were two very separate issues, he added.
To some wary investors, the finer points don’t matter. “With the Enron lynch mob on the rampage, anyone who sticks his head this far above the parapet is bound to get a noose put around it,” said one Wall Street onlooker.
Elan does have some strong similarities to the ruined Texas energy company. In particular, it used innovative accounting methods to make itself more appealing to investors, becoming a master of the products.
Some of these are similar to the partnerships that have come under fire since the Enron debacle first hit. These off-balance-sheet vehicles bundle together groups of assets, be they equity investments or just financial assets, and then securitize them to raise debt for other uses.
In 1999, the Securities and Exchange Commission investigated Elan’s use of this tool to boost its earnings and Elan was forced to clean up its balance sheet. U.S. investors argue that Elan’s clean-up job was merely cosmetic, however.
“What’s since been disclosed is that the problem was not limited to a handful of off-balance sheet partnerships where [Elan] in effect lent themselves money to sell themselves their own equipment and reported it as revenue, and that in fact there were 50 or 60 such entities – all of which have been used to report revenue which is not revenue.” said Fred Isquith, a partner at Wolf Haldenstein Adler Freeman & Herz LLP, one of the law firms representing disgruntled U.S. investors.
Analysts insist that investors should have been aware of these dealings, in particular two “qualified special-purpose vehicles” called EPIL I and II, because they are totally consolidated on the firm’s Irish statements. But these were taken off the balance sheet for U.S. Gaap purposes, according to analysts.
However, the aggrieved investors think the company has been failing to meet U.S. accounting standards. “The law of the U.S. is that when you have your shares traded here, that foreign corporations must file financials at least once a year, in accordance with generally accepted accounting principals and Elan failed to do that. It did not comply with American law,” said Wolf Haldenstein’s Isquith.
Elan’s management disputes this claim and plans to “vigorously defend” itself against the impending lawsuits. But the firm faces a host of issues that, when combined, may prove insurmountable in today’s market environment. Having announced that earnings would have been much lower had management taken into account losses from the EPIL vehicles, Elan officials also said to expect slower product sales going forward. Elan also predicted increases in marketing spending, R&D spending and acquisition activity.
Mairin Burns can be contacted at:Mairin.Burns@tfn.com