Some old wounds have finally healed at Medco Health ( MHS).

Following a two-year investigation, prosecutors from 20 states this week agreed to settle unfair-trade charges against the giant pharmacy benefit manager. The states are set to receive a total of $29.3 million -- and a pledge for improved business practices -- from the nation's largest PBM. Massachusetts has negotiated an additional settlement, pegged at $5.5 million by The Boston Globe.

The federal government has endorsed the deal, offering support for the changes to Medco's business model, but continues to pursue monetary damages of its own. U.S. Attorney Patrick Meehan, who filed a sweeping whistleblower complaint against the company last year, celebrated progress in the case on Monday.

"Although the settlement of the United States' claims against Medco for injunctive relief does not resolve the remaining counts of the amended complaint filed against the company in December 2003," Meehan said, "we believe that the changes in Medco's business practices resulting from this agreement will positively impact health care consumers across the nation."

Medco still faces a multicount federal complaint that accuses the company of, among other things, defrauding federal customers by shorting -- and even canceling -- their mail-order prescriptions. But the new multistate agreement settles charges that Medco violated unfair-trade laws by switching customers to expensive drugs and then pocketing rebates from the manufacturers. Going forward, Medco may pursue such changes only after informing the proper parties and ensuring that the switches will actually save customers money.

Medco itself praised the arrangement.

"The resolutions with the attorneys general and the Justice Department represent significant milestones in Medco's effort to put its portion of the industrywide litigation behind us," Medco CEO David Snow announced. "This arrangement is consistent with our goal to position Medco as the most transparent company in our industry."

The entire PBM sector is under fire for allegedly engaging in business practices that cost -- rather than saved -- customers money. But Wall Street has nevertheless embraced the highly profitable industry.

To be sure, the latest settlements will barely dent Medco's earnings. Granted, the special charges are expected to knock a nickel -- or 10% -- from Medco's first-quarter profits. But the company's full-year guidance remains intact.

Analysts saw plenty to celebrate.

"The $29.3 million monetary component is modest relative to Medco's projected cash flow," noted Banc of America analyst Robert Willoughby, who has a neutral rating on Medco's shares. And "as part of the settlements, Medco does not have to admit to any inappropriate business conduct, which should help lift not only Medco's stock but those of other PBMs as well."

But the sector failed to rally. Medco's largest peer, Caremark ( CMX), actually slid 8 cents to $34.52 on Monday. And Medco itself spiked just briefly before settling in with a modest jump of 19 cents to $35.22.

Apparently, the federal lawsuit -- which some believe cost Medco its big government contract -- continues to weigh on the company.

"We view today's agreements very positively, as they remove part of the large legal overhang on the company," wrote J.P. Morgan analyst Lisa Gill, who also has a neutral rating on Medco's stock. "However, we believe the ultimate resolution of the federal investigation -- including all monetary aspects -- will prove a more significant catalyst for Medco shares."

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