Pressure Builds on Medco, Peers

The so-called pharmacy benefit managers face congressional scrutiny over their Medicaid billing.
By Melissa Davis ,

Last month,

Caremark

(CMX)

showed up in federal court for a case management conference that proved to be less routine than it sounds.

For starters, the pharmacy benefit manager -- or PBM -- learned there about a Medicaid investigation that has been building against the company for years. Even Wall Street, which has long embraced the embattled PBM industry, seemed rattled by the development. Shares of Caremark slumped 2.1% when

TheStreet.com

broke the news.

But that court hearing exposed more than a Caremark investigation. It also highlighted risks that PBMs face with government programs even as they push aggressively into the Medicare business. In addition, it featured rare public criticism of federal prosecutors who, some feel, should be targeting even more companies suspected of bilking the government.

Republican Charles Grassley, chairman of the powerful Senate Finance Committee, is leading the push for that crackdown. Grassley believes the Justice Department has failed to capitalize on a federal law that makes possible high-stakes whistleblower cases like the one pending against Caremark. Thus, he is calling for more staff -- and even a new DOJ branch -- so the government can better chase fraud.

Grassley is making his case to both the DOJ and his peers in Congress. His efforts, if successful, could lead to new challenges for a PBM sector already under intense government scrutiny.

But analysts pay little notice to that potential hazard. By now, they have seen PBMs face multiple legal challenges and emerge virtually unscathed. Thus, they tend to focus more on the sector's opportunities -- such as the new Medicare drug benefit -- than on its potential risks. And they treat regulatory threats as mere footnotes in their bullish reports, if they acknowledge them at all.

Wall Street Winners

Take Prudential analyst David Shove, for example.

Just last week, Shove launched coverage of

Medco

(MHS)

-- Caremark's larger peer -- with a buy recommendation. He sees plenty to like about the company. He talks about Medco's "unmatched size," its "solid management team," its "appetite for growth" and its ability to "redefine the industry landscape." He estimates the company will increase per-share earnings by a solid 12% this year and by an even greater 18% next. And he expresses particular excitement about the company's new Medicare opportunities.

Of all the major PBMs, in fact, Shove views Medco as the biggest beneficiary of Medicare reforms that will soon offer prescription drug coverage to the swelling senior population.

"Medco's forward-looking approach to the Medicare drug program should offer success as this government program alters the industry structure," Shove wrote. "Our overweight rating reflects our belief that there is significant upside in these shares."

Shove then goes on to downplay Medco's regulatory risks. He says the company "took a bold step" that reduced its exposure by settling a multistate probe last year. But he totally overlooks a related federal investigation -- with potentially huge damages -- that continues to move toward trial.

Medco, up 1.6% to $48.32, is currently trading near an all-time high.

Shove seems to exercise more caution with Caremark and fellow PBM

Express Scripts

(ESRX)

by issuing neutral recommendations on both. However, he bases his ratings primarily on valuation -- which he views as fair for both companies -- and potential competitive challenges created, in part, by larger rival Medco.

Furthermore, Shove believes that Caremark's role in the Medicare drug program could prove somewhat limited and Express Scripts' role even more so. And he warns that "it will likely be difficult, if not impossible, to remain outside this program and remain competitive."

Shove expresses far less concern about the "significant" but "manageable" legal risks facing the companies.

Caremark rose 1.3% to $39.20 on Friday. Express Scripts slipped less than 1% to $83.30.

Medicaid Matters

Meanwhile, another probe continues to brew.

Both state and federal authorities have expressed an interest in pursuing Caremark for alleged Medicaid fraud. They would like to see Caremark repay the government for prescriptions used by recipients of Medicaid who have alternative health care coverage as well. By law, Medicaid is the "payer of last resort" and should cover drug costs only when no other health insurance exists.

So far, however, Medicaid has managed to recover only a fraction of the money -- estimated at hundreds of millions of dollars annually -- that is allegedly owed by third parties like Caremark.

Jefferies analyst Glen Santangelo dismisses the state case involving Caremark as a mere Medicaid "contract dispute." However, he voices some concern about the federal case -- based on a 6-year-old lawsuit in Texas -- that was first exposed in a recent article by

TheStreet.com

.

"The article mentioned that the Justice Department is looking at whether to join the Texas case," Santangelo wrote. "And we believe this is probably the more critical issue for investors."

Still, even Santangelo foresees little fallout in the end. For example, he doubts that Caremark's core strengths -- such as its mail-order business, its specialty drugs and its generic sales -- will be affected by the Medicaid controversy. And he ultimately questions whether Caremark engaged in any wrongdoing at all.

After all, he says, the whistleblower case was filed at a time when fellow PBM Medco -- and indeed the entire industry -- faced intense government scrutiny. Thus, he finds it hard to believe that PBMs "would be knowingly acting in a systematic and fraudulent manner" during that period.

The PBMs themselves have consistently defended their business practices and denied any wrongdoing.

"We would not totally dismiss today's news and will continue to monitor the situation closely," Santangelo concluded earlier this month. "However, we find it very difficult to believe that any of these issues would trigger a fundamental change to the business model or to our investment thesis."

Sustained Scrutiny

Patrick Burns, a spokesman for Taxpayers Against Fraud, views the situation differently.

For one thing, he says that some companies have in fact engaged in serious wrongdoing while under the microscope. He uses Highmark, a Pennsylvania insurance company, to illustrate his argument. He says the company was among dozens nailed a decade ago for making Medicare cover services that should have been paid for by themselves. But he says the company ignored its own settlement agreement with the government and continued to bilk Medicare instead.

Highmark itself has denied any wrongdoing. But Burns calls the company a repeat offender that -- due to its treatment of Medicare -- has found itself under investigation once again.

Burns portrays Medicare, like Medicaid, as a "secondary payer" that should cover health care services only when no private insurance exists. Thus, he sees "breathtaking parallels" between the Highpoint and Caremark cases. And he expresses grave concern about PBMs like Caremark now expanding into the Medicare business.

"If companies like Caremark and Medco are already violating secondary payer laws, they need to be nailed hard," he said. "This cannot be the cost of doing business."

Every year, the DOJ collects roughly $1 billion from companies that are accused of violating the False Claims Act. But Burns, for one, questions whether that sum is nearly enough. Right now, he says, the public has no way of knowing if the punishment even comes close to matching the crime. After triggering $13 billion worth of penalties, he says, the Act has still failed to achieve its purpose.

"The goal is not to slow down the speed and amount of fraud," Burns says. "It is to change the way that companies do business."

Texas Tough

Texas, where the Caremark case is pending, has attempted to do just that.

The state has made a name for itself by fighting Medicaid fraud in particular. In recent testimony before Congress members, Patrick O'Connell -- a Texas prosecutor and chief of the civil Medicaid fraud unit -- highlighted both the state's accomplishments and its challenges. He specifically touted the state's recovery of some $45.5 million from drug-related companies accused of bilking the Medicaid program.

"In both cases, Texas recovered more than two times the actual damages to the Medicaid program, plus our costs and attorneys' fees," O'Connell said. But "despite our efforts, some unscrupulous manufacturers continue to devise ways to defraud Texas Medicaid, and we are doing everything in our power to bring those companies to justice."

O'Connell gave credit to former state Attorney General John Cornyn for launching the Medicaid fraud unit in the first place. Cornyn has since joined the U.S. Senate and is now helping Grassley push for more action at the federal level.

Even a federal judge -- and former DOJ prosecutor -- has suggested the need for improvement. In last month's court hearing, Judge Joe Brown called it "unconscionable" that federal prosecutors have spent six years just deciding whether or not to pursue the Caremark case.

Grassley sees major shortfalls in the program.

"In a nutshell, I believe that the department's administration of the False Claims Act lacks vision, transparency, energy, authority, goals and resources -- almost everything a program should have to succeed," Grassley said in a letter to U.S. Attorney General Alberto Gonzales. "I do not believe the False Claims Act is being used to its full potential, and the promise of the act has not yet been fulfilled as Congress intended."

Thus, Grassley is promoting major changes. Burns -- citing the senator's powers -- gives the proposed legislation a "high chance" of passing in Congress. He personally views the measure as quite fair.

"Grassley believes that accountability is not just something that companies like Caremark and Medco should be engaged in," Burns said. "He believes the DOJ should be engaged in it as well. ... All he asks is that the DOJ be held to the same standards that it asks of everybody else."

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