CVS Neither Admits Nor Denies Charges, to Pay $20 Million to Settle SEC Charges

CVS Caremark will pay $20 million to settle charges brought by the Securities and Exchange Commission (SEC) alleging that the company misled  investors about significant financial setbacks and used improper accounting that artificially boosted its financial performance.

In settling the case, CVS neither admitted nor denied the charges.

CVS was represented by Lawrence Portnoy of Davis Polk in New York.

CVS has two business segments as a pharmacy benefits manager and a retail chain of drug stores.

In offering documents for a $1.5 billion bond offering in 2009, the SEC alleged that CVS fraudulently omitted that it had recently lost significant Medicare Part D and contract revenues in the pharmacy benefits segment.

Investors were therefore misled about the expected future financial results for that line of business.

When CVS eventually revealed the full extent of the setbacks on Nov. 5, 2009, its stock price fell 20 percent in one day.

The SEC said that CVS also misled investors on an earnings call that same day by maintaining there was a slight improvement in its “retention rate,” which is a key metric of retained business often used to compare pharmacy benefits management companies.  But CVS omitted the fact that it had manipulated how it calculated the rate and concealed the full extent of its lost business.

“CVS broke faith with investors in both its stock and its bonds by disguising significant setbacks for its pharmacy benefits management business,” said Andrew Ceresney, director of the SEC’s Division of Enforcement.  “The intentional misconduct by CVS breached the core principle of fair and accurate reporting of financial performance.”

The SEC’s complaint alleges that CVS made improper accounting adjustments that overstated the financial results for its retail pharmacy line of business.  During the same 2009 timeframe,

CVS altered the accounting treatment for its acquisition of another drug store chain – Longs Drugs – and failed to disclose the adjustments in its quarterly report filed on November 5.  CVS improperly reduced the value of $189 million of personal property in the Longs stores down to $0, and then reversed $49 million of depreciation that had been taken on those assets since the acquisition.

The undisclosed depreciation reversal increased the third-quarter earnings and enabled CVS to exceed analysts’ expectations at a time when it was otherwise announcing significant bad news about earnings projections in its pharmacy benefits line of business.

The SEC alleges that the improper accounting adjustments were orchestrated by Laird Daniels, who was the retail controller at CVS and is charged with accounting violations in a related SEC administrative proceeding.

According to the SEC’s order against Daniels, proper accounting would have treated the asset write-down as a current period expense, and the third quarter earnings per share for CVS would have been reduced by as much as 17 percent.

As Daniels described in an e-mail, the dramatic change in accounting turned the acquisition of Longs Drugs from a “bad guy” to a “good guy” in terms of purported profitability for CVS.

“The accounting standards are designed to provide the public with a fair and consistent measure of public company performance.  Instead, CVS and Daniels used improper accounting tactics to give investors a misleading picture of the company’s retail pharmacy earnings,” said Paul Levenson, director of the SEC’s Boston Regional Office.

Daniels settled the administrative case against him by paying a $75,000 penalty and being barred for at least one year from practicing as an accountant on behalf of any publicly traded company or other entity regulated by the SEC.

Without admitting or denying the allegations, Daniels agreed to the entry of a cease-and-desist order finding that he willfully violated Sections 17(a)(2) and (3) of the Securities Act of 1933 and Rule 13b2-1 under the Securities Exchange Act of 1934.

Daniels was represented by Robert Cleary of Proskauer Rose in New York.

The order finds that Daniels willfully aided, abetted, and caused violations by CVS of the reporting, books and records, and internal control provisions of the federal securities laws.

The SEC’s complaint charges CVS with violations of Section 10(b) of the Exchange Act and Rule 10b-5, and Section 17(a) of the Securities Act.

CVS also is charged with violations of the reporting, books and records, and internal control provisions of the federal securities laws.

In addition to the $20 million penalty, CVS consented to the entry of a final judgment permanently enjoining the company from violating various anti-fraud, books and records, and internal control provisions of the securities laws.

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