Risk Management

A Case of Overstuffing Plush-Toy Values

Former CVS Caremark execs settle SEC charges that they did just that, improperly accounting for inventories in a scheme devised after CVS decided t...
Stephen TaubJuly 2, 2007

The Securities and Exchange Commission settled civil charges with two former CVS Caremark Corp. finance executives over a scheme that involved overvaluing the former CVS Corp.’s inventory of stuffed animals seven years ago.

Without admitting or denying the allegations, former controller and principal accounting officer Larry Solberg and former treasurer Philip C. Galbo each agreed to pay a $30,000 civil penalty. In addition, Galbo will pay $22,000 in disgorgement, along with prejudgment interest of more than $8,700, while Solberg will pay $16,000 in disgorgement, and prejudgment interest of more than $6,000.

For its part, Woonsocket, R.I.-based CVS Caremark agreed to an order requiring the company to cease and desist from committing or causing any future violations of certain books and records provisions of the federal securities laws. The alleged accounting violations occurred before the merger of pharmacy chain CVS with Caremark earlier this year, forming a pharmacy services giant.

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CVS, which had determined at year-end 1999 to hold over its plush-toy business at full value, in April and May 2000 determined that it would terminate the business, according to the SEC.

The complaint said that Galbo and Solberg became aware in the late spring and summer of 2000 that the company was carrying the plush-toy inventory on its books at $32 million, much higher than the $13.9 million approximate market value at the time. But instead of writing down the inventory’s value, CVS entered into a transaction with a barter company under which the pharmacy chain agreed to exchange the inventory for credits with a face value of $42.5 million. CVS then replaced the $32 million toy inventory on its books with the credits at a value of $42.5 million, according to the SEC.

The transaction, which the SEC said was negotiated by Galbo and approved by Solberg, allowed for an exchange in which the barter company received no goods or services from CVS, according to the complaint. Rather, it received $12.5 million in cash.

Under terms of the deal, the barter company transferred the $42.5 million in credits, and CVS liquidated the inventory in its capacity as agent for the barter company, while guaranteeing the barter company the $12.5 million. CVS valued the credits on its books at their full face value of $42.5 million, according to the regulator.

According to the SEC, evidence existed that the credits — consisting of $18.8 million in telecommunications credits and $23.7 million of credits — should not have been recorded at their face value. Both Galbo and Solberg, the complaint said, should have known that not taking an impairment charge to the plush toy inventory was incorrect.

The result was that CVS overstated its pretax earnings for the third quarter of 2000 by roughly $18.1 million, or about 7 percent of net income, according to the SEC.

Under the settlement deal, Galbo and Solberg each agreed to an order requiring them to cease and desist from committing or causing any future violations securities laws, and books and records provisions.

In addition, Solberg agreed to be barred from practicing accounting before the commission, although he may reapply after one year.