The market is ignoring a massive elephant in the room at Valeant

Guys, there's something missing here.

Two former executives - from Valeant Pharmaceuticals and its now-defunct pharmacy Philidor - have been arrested and charged with committing fraud to personally enrich themselves.

We're talking alleged kickbacks, some wire fraud, Travel Act Conspiracy. But what's missing is any mention of anything that the Department of Justice has been investigating Valeant for, for over a year.

And, more importantly, what's missing from Thursday's complaint tells us this is far from over.

Valeant has told us, media have reported, and investors allege that there was more to the Valeant/Philidor relationship than a couple of guys trying to pull a fast one on a huge company. We have heard allegations of insurance fraud, for example, price gouging and lies about Valeant's growth.

None of that is addressed here.

According to the complaint filed in the Southern District of New York (SDNY), Philidor CEO Andy Davenport and Gary Tanner colluded to ensure that Valeant would buy Philidor for $100 million, which it did at the end of 2014. That purchase, as we know, was not disclosed to investors and contributed to Valeant's epic near-collapse last year.

Tanner, who worked at Valeant before leaving for Philidor in 2015, was promised a cut of what Valeant paid Davenport as the company's relationship with Philidor grew. He did not disclose to Valeant that he had a financial interest in the deal.

In a press release Valeant said (emphasis ours) "the company, former CEO, former CFO, and current executives have not been charged at this time."

Valeant's stock initially fell around 5% on this news, but has since recovered to continue the day flat.

Putting in work

Officials at the SDNY have been investigating Valeant since at least October 2015. That's when the company says it received subpoenas from the SDNY and state attorneys in Massachusetts.

And this is what those investigators were looking for:

The materials requested by those offices, pursuant to the subpoenas and follow-up requests, include documents with respect to the Company's patient assistance programs (including financial support provided to patients); its former relationship with Philidor and other pharmacies; the Company's accounting treatment for sales by specialty pharmacies; information provided to the Centers for Medicare and Medicaid Services; the Company's pricing (including discounts and rebates), marketing and distribution of its products; the Company's compliance program; and employee compensation.

The arrests made on Thursday are about the actions of two individuals to get money out of their customer (in Davenport's case) or employer (in Tanner's case).

They are not about any shady activity going on at Philidor that Valeant may have known about, which is to say, they are not about the pricing, marketing, compliance or compensation issues that SDNY has been looking in to. They also don't address the alleged defrauding of insurers that the Wall Street Journal reported was part of the investigation, in August.

Valeant investors, like TIAA-CREF and T. Rowe Price are seeking answers to these questions themselves.

They have, in lawsuits, accused Valeant of not only shirking its duty in failing to disclose the existence of Philidor, but also of allegedly engaging in fraud in order to get insurers to pay for expensive Valeant drugs when they normally would reject said payments.

Rejected payments are mentioned in the complaint against Davenport and Tanner. There, as in internal Valeant documents Business Insider viewed, they are referred to as Alternative Fills (AFs). They were a big problem for Valeant, and T. Rowe Price alleges that executives at Valeant must have known about the "fraudulent scheme" Philidor was running in order to reduce their volume.

In its complaint, T. Rowe Price accuses Valeant of lying about its growth, its price gouging practices, Philidor, its other "captive pharmacies," its use of patient assistance programs to preserve high prices, the depth of its legal risk, and its lack of compliance and controls.

In a press conference following the arrests, Bharara refused to discuss any continuing investigation into Philidor.

You think you know a guy

In its complaint, TIAA-CREF pointed out that Valeant and its executives actually did their due diligence into Philidor. They visited the facility a bunch.

Prior to obtaining the option to acquire Philidor, Pearson, Schiller, and Valeant's Board of Directors engaged in due diligence, which included multiple site visits. In fact, the majority of Valeant's Board of Directors, including the entire Audit and Risk Committee, went to tour the Philidor facility in Pennsylvania in person and prior to the transaction. In addition, Valeant's entire Board of Directors, including the Finance and Transactions Committee and the Audit and Risk Committee, reviewed and approved the Philidor transaction and the accounting treatment that violated GAAP.

This shouldn't surprise anyone familiar with the Valeant story. Former CEO Michael Pearson held a tight grip on the company. It was his dominance, in part, that made the company a Wall Street darling. Investors believed Pearson, a McKinsey alum, had created an unbeatable business model.

The problem, these investors allege, was that Pearson's model was in large part dependent on fraud.

"I find it difficult to believe that someone we know is a control freak didn't know anything about this," said short seller Andrew Left of Citron Research.

It was Left's report on Valeant last year, along with stories from Roddy Boyd of the Southern Investigative Reporting Foundation, that revealed Philidor's existence to Wall Street. At the time, Left compared the company to Enron - the American energy giant that went bankrupt after short sellers and reporters revealed that it was generating phantom revenue - simple accounting fraud.

For Valeant, the very least we know is that things are not that cut and dry.