Hedge-fund darling Valeant got eviscerated by a short seller over its accounting practices, including some just-revealed “specialty pharmacies” it allegedly used to inflate revenues. The company is denying the allegations. But now everyone has started digging.

This comes on top of the interest Congress is finally showing in the rampant price increases of generic drugs. It has become a business model in the US: Hedge-fund like companies such as Valeant plow into the health-care sector with huge amounts of other people’s money and gobble up makers of generic drugs. After the buyout, they jack up prices. They can because there are no competitors, and regulators stay dutifully out of sight.

Valeant’s shares have plunged 56% in less than three months. Its bonds and leveraged loans have sold off sharply. The junk-rated, over-indebted company is going to have a hard time borrowing cheaply to continue its buyout spree.

Regulators – asleep, powerless, or just totally compromised by the revolving door, pharma lobbyists, and regulatory capture – allow or encourage industry abuse of regulations and patent laws. This leaves the industry rife with unregulated monopolistic structures.

So health-care expenses are eating up 17.4% of the US economy, or they’re generating 17.4% of GDP, the highest proportion in the world. Whichever way you look at it, this portion of GDP comes out of your pocket directly or indirectly, one way or the other.

But life expectancy in the US is only 78.8 years, three years less than Canadians’ whose health-care system is vilified in the US. According to the World Health Organization, the US is in 37th place, between Qatar and Barbados and only a rounding error ahead of Cuba. You’re not paying for extending your life expectancy. You’re paying for the health-care industry’s soaring revenues and profits.

In 2015, the health-care sector in the S&P 500 will likely see revenues soar by 8.3% and earnings by 11.3%, according to FactSet, even as all S&P 500 companies combined will have zero earnings growth and suffer revenue declines for the fourth quarter in a row. But don’t blame Obamacare – this has been going on for decades.

With regulators and Congress compromised by the health-care sector, which has become so big that no one wants to take it on, who is left to crack down on the abuse?

Short sellers.

They couldn’t care less about life expectancy or what is bankrupting Americans. They’re driven by the profit motive. They’re trying to figure out how to make money from cracking open industry secrets, peeling away covers, digging for deceit, exposing lurid details, or challenging patents in court.

Short-sellers are despised and maligned. Governments barely tolerate them. And when markets head south, governments don’t even tolerate them: they limit short selling, as they did during the Financial Crisis, or they threaten short-sellers with arrest, as in China recently.

Their risk-reward relationship is totally out of whack: they have a maximum potential gain of 100% if the stock goes to zero but an infinite potential loss that could take down the firm.

And they’re trying to do all this in an era when central banks are hell-bent on inflating stocks and bonds. In that hyper-liquid environment, even the worst sinners can get a boost and new money, with terrifying results for short sellers.

It’s a thankless way of trying to make a buck.

In Valeant’s case, it was Citron Research, run by a short-seller. After the report, “Valeant: Could this be the Pharmaceutical Enron?” became public, Valeant’s already swooning shares crashed another 30%. It woke up the media, and now reporters are sniffing around as well.

Then there’s the Coalition for Affordable Drugs’ (CAD), a group of hedge funds formed by Kyle Bass. The goal is to make money by shorting pharmaceutical companies and then challenging their “BS patents,” as Bass had put it so eloquently, with the goal of invalidating the patents. A patent law change in 2012 established new procedures to challenge patents, including by third parties, such as hedge funds.

A patent gives the drugmaker a legal monopoly for a specific period of time. Then the free market is supposed to take over with generics and bring down prices. But these patents have become rubbery, and their anti-competitive protections are stretched by hook or crook to absurd length and directions. This keeps generics off the market. And Americans are paying out of their nose for these drugs.

In a letter to the House Judiciary Committee in April, commenting on a congressional proposal to change the rules for patent litigation, Bass said that some pharmaceutical companies “have engaged in abusive practices by acquiring and enforcing weak patents,” according to Bloomberg. “A small number of monopolistic drug franchises that have gone unchecked have become our special focus,” he said.

CAD is challenging a number of patents. But taking on Big Pharma isn’t easy. CAD’s first three efforts didn’t go anywhere. But in September, there was a tepid sign of success in his case against Celgene. And on October 7, in CAD’s case against Cosmo Technologies, the Patent Trial and Appeal Board (PTAB), actually allowed the patent review to move forward. The first sort-of victory.

“We have to wait to see what the ultimate outcome is on these challenges,” explained IP Watchdog. “For now, however, it can no longer be said that the PTAB has closed its doors to Kyle Bass.”

If these “BS patents” are invalidated, generic drugmakers could enter the fray with cheaper versions. CAD would benefit from the hit to the shares of the targeted companies. Consumers, taxpayers, and insurance companies would benefit from cheaper alternatives. In Valeant’s case, investors would benefit from a crackdown on allegedly dubious accounting practices. The losers: targeted drugmakers and the Wall Street hype machine.

It’s not without irony that profit-motivated short-sellers end up on the same side as consumers, taxpayers, and investors who don’t want to be deceived.

The third quarter was tough for US corporations. They got waylaid by weak global demand, lack of pricing power, and the “strong dollar.” It isn’t just the energy sector. For the non-energy companies that have reported Q3 earnings so far, revenues and operating income both dropped. Companies are now cutting costs and laying off people, “though it’s premature to predict impending doom for the current recovery,” Moody’s said to assuage our rattled nerves. Read… This Is Why It’s Going to Get Even Tougher

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