CVS Caremark has agreed to pay $20 million to settle charges from the Securities and Exchange Commission that the drug store giant misled investors about significant financial setbacks and used improper accounting that artificially boosted its financial performance.
According to the SEC’s complaint, which was filed in federal court in Rhode Island, 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, 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 contended that CVS further 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. However, the company 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, in a statement. “The intentional misconduct by CVS breached the core principle of fair and accurate reporting of financial performance.”
The SEC’s complaint also 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,” said Paul Levenson, director of the SEC’s Boston Regional Office. “Instead, CVS and Daniels used improper accounting tactics to give investors a misleading picture of the company’s retail pharmacy earnings,”
Daniels has agreed to settle 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 the securities laws. 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 the securities laws and 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. CVS neither admitted nor denied the allegations. The settlement is subject to court approval.
CVS Caremark Corporation acknowledged Tuesday that it has finalized the SEC settlement, which it had previously announced last August. The company noted that the settlement was entered into on a "no admit or deny basis" and will not require CVS Caremark to restate its earnings for any reporting period. “This matter is now fully resolved for the company and individuals,” said CVS. “As previously announced last year when the company disclosed that it had reached an agreement in principle with the staff of the SEC, the settlement relates to events that occurred in the third and fourth quarters of 2009, including certain public disclosures made by the company and certain aspects of the purchase accounting adjustment related to the October 2008 Longs Drug Stores acquisition.”