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Caremark's Credibility Question

Filings suggest that merger-chasing execs neglected shareholders.



can't seem to get its priorities straight.

When pursuing a merger, most companies would probably like to know just how much of the combined organization their shareholders can expect to own. But Caremark focused on this crucial detail, known as the "exchange ratio," only at the last minute of its lengthy merger negotiations with


(CVS) - Get CVS Health Corporation Report

. The company addressed side issues, such as executive payouts and possible breakup fees, with considerably more urgency.

At least, that's the scenario being painted in court documents filed by rival pharmacy benefit manager

Express Scripts


. Granted, Express Scripts would like to derail Caremark's merger plans and buy the company for itself. But Delaware Chancellor William Chandler felt concerned enough last week to delay a vote on the proposed CVS-Caremark merger so that shareholders could digest important new information surrounding the controversial deal.

Chandler has been asked by Express Scripts to block the CVS merger altogether. He expects to issue a ruling on the matter next week. Caremark declined to answer questions for this story in the meantime.

By now, Chandler has fretted over two major revelations in particular. First, he noted last week, Caremark has just informed its shareholders that the company previously discussed possible deals with Express Scripts -- on at least three different occasions -- after repeatedly telling them, this time around, that such a deal would face huge antitrust issues. Second, he said, Caremark has now admitted to shareholders that they could lose their ability to sue company leaders over suspicious stock option grants if the company completes any sort of merger at all.

In recent rulings involving other companies, Chandler has made it very clear that directors should be held responsible for any stock option shenanigans. Some now smell possible trouble for Caremark leaders as well.

"The probability of director liability for backdating increased considerably" with the recent rulings, wrote CtW Investment Group, a proxy advisory firm opposed to the CVS-Caremark merger. "This powerful language from Chancellor Chandler underscores the seriousness of concerns regarding the Caremark board."

The complaint filed by Express Scripts -- which fills in gaping holes left by Caremark's own disclosures -- further magnifies those concerns.

Matter of Trust

Notably, the filing shows, CVS felt worried enough about Caremark's stock option headaches to stop negotiating with the company for months.

Caremark somehow managed to reassure the drugstore chain and draw it back to the table. But critics remain suspicious of Caremark and its CEO, Mac Crawford, nonetheless.

"It strains credulity to suggest, as Crawford testified, that he is unconcerned about the risk of a criminal charge" for stock option irregularities, Express Scripts' filing states. "Any rational human would be concerned -- whatever his innocence or confidence -- and he would be concerned about who will be controlling the corporate levers that impact these issues.

"In CVS and

its CEO Tom Ryan, Crawford has partners who profess complete trust in him. That must count for much."

So, too, must the legal protection that CVS has promised Crawford and other company leaders.

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Originally, CVS sought to limit the amount it would have to spend on insurance coverage for Caremark's directors and officers. But Caremark wanted CVS to provide that coverage no matter how much it was going to cost. The two companies wound up compromising in the end, court documents show, with CVS capping the premium amount but at a much higher price than it had wanted.

Apparently, payouts to Caremark executives kept escalating as well.

"Management benefits in the merger soared upward and spread to a broader group," Express Scripts claims. "Not surprisingly, the biggest prize in the management bonanza went to Crawford -- the chief proponent of the merger."

But Ryan looks tainted, too.

Notably, Ryan serves on the board at

Bank of America

(BAC) - Get Bank of America Corp Report

. Yet, Express Scripts claims, Ryan failed to disclose this possible conflict when Caremark hired Bank of America to evaluate Express Scripts' buyout offer. Following that evaluation, Caremark declared that Express Scripts' proposal -- which topped CVS' own -- was not in the best interests of its shareholders.

CVS failed to answer a question from

about this particular matter.

Sealing the Deal

Meanwhile, CVS and Caremark took extraordinary steps to seal their own deal. For example, court papers show, they arranged a huge termination fee.

"Negotiations began with the parties intending to provide for a termination fee that was the maximum amount allowed by law and ended with a fee that equaled or exceeded that amount -- including being larger in absolute dollars than any fee ever expressly sanctioned by a Delaware court," Express Scripts states. "Never was there a serious effort to negotiate a smaller or less onerous fee."

Moreover, the filing suggests, Caremark took deliberate steps to shield the deal from unwanted shareholder interference. Specifically, it notes, the company established an inconvenient record date -- on the Martin Luther King Jr. holiday -- for investors looking to buy Caremark stock and provide input on the proposed merger.

As a result, Express Scripts says, investors had only one business day after the record date to become Caremark stockholders with the right to vote on the company's merger plans. Moreover, Express Scripts adds, those investors were never properly informed by Caremark about the situation.

"Caremark formally submitted the Jan. 15, 2007, record date to the

New York Stock Exchange

, which in turn 'announced' the record date through publication in the on-line version of the NYSE weekly bulletin, which is accessed through a password-protected site," Express Scripts notes. "Caremark got the record date it wanted. The result, in which the markets had one full day post-announcement of the record date to acquire Caremark shares, was highly unusual -- particularly in the context of this highly scrutinized contested transaction."

Of course, it seems, Caremark itself knew how it felt to be rushed. After spending a year hammering out the terms of its proposed merger, court filings indicate, Caremark found itself scrambling to determine an acceptable exchange ratio -- after barely even visiting the issue -- right before announcing the deal.

Critics feel that Caremark settled for far too little in the end. Under the terms of the original proposal, Caremark would collect no premium and walk away with less than half of the combined company.

Some critics question why any rationale board would embrace such an arrangement. As a result, they have grown increasingly suspicious of even Caremark's independent directors, who pocketed some favorably priced stock options of their own.

"We believe that any non-executive directors who participated in and profited from improper option backdating have compromised their own integrity and independence from management," CtW wrote when urging Caremark shareholders to reject the proposed merger with CVS. "Caremark's failure to take any affirmative steps to dispel our doubts leaves us wary."

Ultimately, CtW concluded, "we doubt the wisdom of the Caremark board's acceptance of CVS's offer and fear that the combined CVS-Caremark will be led in part by individuals who cannot be entirely trusted" to put shareholders first.