SEC fines Biovail's ex-chairman $1-million

2009-02-03 18:17 ET - Street Wire

by Mike Caswell

The U.S. Securities and Exchange Commission has reached a partial settlement with Eugene Melnyk, the former chairman of Biovail Corp., for allegedly failing to report his ownership of 19 per cent of the company. He has agreed to pay a $1-million civil penalty and to refrain from future violations of the U.S. Securities Act. (All figures are in U.S. dollars.) The settlement was contained in a judgment filed in the Southern District of New York on Feb. 3, 2009. The deal only applies to the portion of the SEC's complaint that alleged Mr. Melnyk failed to properly report his ownership of Biovail. The remainder of the complaint, which alleges that he misled the public about the company's revenue, remains outstanding.

Biovail, which was also a defendant in the case, settled for $10-million on March 24, 2008.

SEC's complaint

The SEC filed a complaint against Mr. Melnyk, Biovail, and three of the company's officers, Brian Crombie, John Miszuk and Kenneth Howling, on March 24, 2008. The suit claimed that the men were obsessed with meeting quarterly and annual earnings guidance and that they repeatedly overstated earnings and hid losses.

The alleged scheme began in mid-2001, when the company sought to increase its income by removing research and developments costs from its books. To do this, Biovail created a company called Pharmaceutical Technologies Corp. to carry those costs, estimated to be as high as $120-million, the SEC claimed. Pharmaceutical Technologies allegedly borrowed $60-million in development costs from the bank using Biovail's royalties as collateral. The SEC said the debt essentially belong to Biovail, because it had agreed to acquire Pharmaceutical Technologies to avoid losing rights to those royalties, but it never reported it.

"Crombie and Biovail deliberately and fraudulently orchestrated the Pharmatech arrangement as a means to avoid ... reporting on [Biovail's] financial statements the expenses and liabilities related to the research and development of certain Biovail products," the complaint read. As a result, Biovail failed to record $51-million in liabilities on Sept. 30, 2002, the SEC claimed. This resulted in the company overstating its net income by 12 per cent in 2001 and 17 per cent in 2002, according to the complaint.

The SEC said the scheme continued in the second quarter of 2003, when the company engaged in a sham bill and hold transaction, essentially selling the same pills twice, so it could record $8-million in revenue. Prior to the sale, the company's revenue was below the low end of its previously issued guidance. "In particular, Biovail had not sold any Wellbutrin XL, a drug that analysts considered crucial to the Company's health and whose sales potential had led some analysts to issue a buy recommendation for the Company," the complaint read. Rather than acknowledge the poor performance, Mr. Crombie and Mr. Miszuk arranged a phony sale with a distributor, the SEC alleged.

In order to book revenue in that quarter, the company convinced its distributor to preorder Wellbutrin pills, according to the complaint. The company had most of the pills in stock, but instead of holding them for the distributor as is done in normal bill and hold transactions, Biovail sold them as samples, the SEC said. "In this way, Crombie and Miszuk sold the same pills twice, at two different prices, to fill two different orders," the complaint read. As a result, the company was able to book $8-million in revenue that quarter, and meet its guidance, the SEC alleged. Biovail later credited the distributor for its original purchase order, the complaint stated.

The company then faced another revenue shortfall in the third quarter of 2003, which it blamed on a truck accident, the SEC said. On Sept. 30, 2003, a truck carrying $5-million worth of Wellbutrin XL (which is used to treat depression) left the company's plant in Steinback, Man., destined for a North Carolina, according to the complaint. It was involved in a multivehicle accident on Oct. 1, 2003. The SEC said Mr. Melnyk and the other defendants then issued numerous false public statements declaring that the accident contributed up to $20-million to Biovail's revenue shortfall for the quarter.

This was not the case, the SEC said. "The truck accident had no impact on Biovail's financial results for the quarter, as Biovail, Melnyk, Crombie, and Howling knew or recklessly disregarded," the complaint read. The shipment became the responsibility of the distributor as soon as it left Biovail's plant, the SEC alleged. In addition, under U.S. generally accepted accounting principles, the shipment could not be booked as revenue until it had reached the distributor's warehouse, the SEC claimed. "Under those circumstances, Biovail could not have recognized revenue resulting from the shipment regardless of the accident," the complaint stated.

In addition to those allegations, the SEC claimed that Mr. Melnyk failed to report his ownership of 19 per cent of Biovail. On Sept. 23, 1996, he allegedly formed four Cayman Island trusts and transferred Biovail shares to them. He paid the controller of Biovail's Barbados subsidiary to assist with the trusts, the SEC said. Mr. Melnyk directed the selling and voting of those shares. He also borrowed $100-million against them, causing the trust to have to sell some of the shares.

The SEC sought appropriate civil penalties against the defendants, plus orders banning them from serving as officers or directors of public companies. Mr. Miszuk, Mr. Crombie and Mr. Howling have not answered the complaint, and Mr. Howling and Mr. Miszuk have unsuccessfully sought to have portions of it dismissed.

Hg