Caremark Ready to Roll

The CVS merger can't obscure challenges ahead, though.
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CVS

(CVS) - Get Report

and

Caremark

(CMX)

are getting ready to run a victory lap.

Caremark shareholders are due to vote Friday on a $26 billion merger between the two pharmacy giants. The road to the point has been a long and twisting one, replete with an unsolicited buyout bid from

Express Scripts

(ESRX)

, a very public feud between Caremark and its unwanted suitor and a number of trips to court.

Despite claims to the contrary from many sides, Caremark shareholders seem to be shaping up as the winners. Their shares have soared more than 20% since the CVS deal was announced in November.

Since then, CVS -- under pressure from a higher offer pending from Express Scripts -- has sweetened its deal three times. Meanwhile, Express Scripts has mostly stood pat while protesting that it can't raise its bid without seeing Caremark's books. The CVS sweeteners, combined with regulatory questions tied to the Express Scripts deal, appear to have paved the way for what CVS and Caremark have called a landscape-changing deal.

The prospect of victory can't obscure the challenges that lie ahead for CVS, however. (For a look at an issue confronting Express Scripts,

click here.)

On Tuesday, a federal appeals court cleared the way for Tennessee's Medicaid program to pursue a case in which it seeks to recover costs from Caremark.

George Caram Steeh, a federal appeals judge in the Eastern District of Michigan, upheld an earlier decision in a case that has been dragging on for years. Caremark has denied any wrongdoing, but those familiar with the case have estimated Caremark's potential liability at "hundreds of millions of dollars."

Medicaid is the so-called payer of last resort, meaning that third parties -- such as Caremark -- are obligated pick up the tab for customers that are covered by Medicaid as well. Caremark has refused to repay the government agency, however, when Medicaid recipients fail to present their Caremark cards to pharmacies or when Medicaid misses Caremark's deadlines for seeking reimbursement.

The federal appeals court found serious flaws in that stand.

"It is axiomatic that TennCare -- a state agency that does not possess a Caremark card -- could never comply with the card presentation requirement," Steeh declared. "Likewise, because TennCare cannot seek reimbursement from Caremark until it receives a claim from a pharmacy and subsequently discovers that the beneficiary is a dual eligible covered by Caremark, TennCare is often unable to comply with the plans' timely filing limitations.

"Caremark's procedural plan provisions -- the card presentation and timely filing restrictions -- inappropriately shift Caremark's responsibility to pay pharmacy benefits on behalf of a plan participant onto the government."

TheStreet.com

first exposed the Medicaid investigation of Caremark two years ago.

Meanwhile, some critics continue to question other aspects of the Caremark-CVS deal.

Proxy advisory firm CtW points out that Caremark leaders -- who have scored some well-timed stock option grants in the past -- could see their exposure to backdating lawsuits disappear.

CtW fears that Caremark leaders, including outside directors and company executives alike, have been compromised as a result. The firm challenges the credibility of Caremark's two key attorneys in particular.

"We note that both (Assistant General Counsel Sara) Finley and General Counsel Edward Hardin themselves received questionably timed options in 1998, 1999 and 2001," CtW complained back in January. "Moreover, according to both the Tennessee Bar Association website and the Martindale-Hubbell legal directory, it appears that Mr. Hardin is not licensed to practice law in Tennessee.

"If this is the case, his employment as general counsel at (Nashville-based) Caremark would appear to constitute the unauthorized practice of law, further calling into question the propriety of Caremark's compensation practices and overall internal controls."

Caremark spokesman Jeffrey Mathews told

TheStreet.com

that Hardin is licensed to practice law in Alabama, where the company was headquartered until 2004, but has not obtained a law license for the state of Tennessee. However, Mathews said, Harden is a corporate lawyer who never litigates cases in Tennessee courts and would have secured a license there if he did.

To be fair, the CVS-Caremark merger has won over some fans.

The M&A Researcher has, in fact, predicted that CVS would prevail all along. The firm has defended the proposed merger, despite the generous rewards promised to Caremark executives, in the process.

"There is obviously nothing new or unethical about executives from a target company receiving substantial -- even absurd -- awards for agreeing to a formal merger agreement," the M&A Researcher insisted in late January. "Several reports have surfaced ... suggesting the deal may be threatened by the perceived inappropriate perks being offered to CMX executives."

However, the firm added, "this seems to (be) farfetched and perhaps wishful speculation from sources hoping to inject additional controversy into an already volatile situation."