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Hedge fund manager Bill Ackman said Wednesday that he purchased an additional 2 million shares of Valeant Pharmaceuticals as the stock plunged following the release of an explosive note from Citron Research that alleges the drugmaker is channel stuffing.
Ackman told CNBC that he believes in the company despite Citron claims. His firm, Pershing Square, was already one of the largest holders of Valeant stock.
Citron alleges that Valeant is using a network of specialty mail-order pharmacies that the company actually controls to prop up sales of its high-priced drugs and to keep patients and their insurance companies from switching to less costly generics.
The report goes so far as to call Valeant the "pharmaceutical Enron."
Valeant shares plummeted more than 39 percent before recovering after a press release from the company denied the Citron report. The stock eventually closed the day down about 19 percent.
Citron's founder Andrew Left confirmed to CNBC that he is short the stock, which is down more than 60 percent from a record high hit in early August.
Left's report begins by referencing a Monday New York Times story on the possible improper use of specialty pharmas by drug companies. He then cites a report from investigative journalist Roddy Boyd on his Southern Investigative Reporting Foundation website questioning the exact nature of Valeant's relationship with these pharmacies.
Citron claims that the specialty pharmaceutical companies in question — Philidor RX and R&O Pharmacy — are actually the same company with the same management. The short selling firm presents as evidence patient privacy disclosure forms from both companies that appear to be almost exact copies except for a change in the company name. Both companies also share the same privacy officer contact phone number, according to Citron.
On Valeant's earnings call Monday, CEO J. Michael Pearson said the company has a "contractual relationship" with Philidor and an option to acquire Philidor "if we so choose."
Pearson also acknowledged that Valeant has contacted R&O about providing payment for amounts it has received for Valeant drugs.
"We will refrain from comment on active litigation and look forward to showing in court that we are owed the money," he said on the call.
In his report, Citron's Left said:
"While it is impossible for Citron to state for certain at this point, this has the distinct aroma of product being jammed into a channel. It had to have started small, and now it's just too big. 'We have an option to purchase Philidor' is simply ... trying to put the genie back in the bottle...Citron Research has delivered the proof that something really stinks at Valeant and it is goes beyond their egregious price hikes."
Valeant called the report "erroneous" in a press release.
"There is no sales benefit from any inventory held at these specialty pharmacies and inventory held at the Philidor network pharmacies is reflected in Valeant's reported inventory levels," said the release.
In an apparent effort to clarify confusion about the relationship between Philidor and R&O, the company said in the release that "Philidor Rx Services is a pharmacy licensed in Pennsylvania and also provides back-end services, including call center, claims adjudication, IT and logistics support, as well as compliance/HIPPA regulation guidance, to other pharmacies, including R&O Pharmacy."
The back-end service function would explain why phone numbers and forms between Philidor and R&O are the same.
In a separate statement to CNBC, Valeant accused Citron of manipulating the market in an effort to drive down the company's share price.
Citron Research is a controversial, but often successful firm. It is perhaps best known for its report on Longtop Financial Technologies in April 2011, which questioned the veracity of the company's financial statements. Citron was later validated by the market as the shares were delisted and the SEC revoked the company's registration. At the same time, Left has his own checkered record, having once been disbarred for three years by the National Futures Association.
Outrage about the practice of pharmaceutical firms increasing prices on drugs exploded at the end of last month after a New York Times report on little-known company Turing Pharmaceuticals run by Martin Shkreli. This report was later cited by presidential candidate Hillary Clinton as a reason to look into this practice.
Shares of the whole biotechnology sector have fallen since then as a result of possible inquiries by the FDA and others into pricing practices.
Allergan, whose shares also fell following the Citron report, released a press release midday saying it "does not rely on specialty pharmacies for the distribution of its products." Allergan was not accused of any wrongdoing in the short seller's report.
Valeant was subpoenaed by federal prosecutors last week, in part because of its distribution practices.
Billionaire hedge fund manager Bill Ackman is the third-largest shareholder in Valeant through his firm Pershing Square Capital Management, according to the most recent public filings.
Fran McGill, a spokesman for Pershing Square, declined to comment on the Citron report. He would not say whether Pershing sold or increased any of its stake in Valeant. Reuters estimates Pershing has lost more than $800 million on the position Wednesday.
The stock is a favorite among notable hedge fund managers. John Paulson's Paulson & Co. is the fifth-largest shareholder, according to filings.
— CNBC's Tae Kim and Scott Wapner contributed reporting.