Opinion ID: 3014742
Heading Depth: 2
Heading Rank: 1

Heading: Medco’s revenue-recognition policy

Text: Medco is a pharmacy benefits manager (PBM). It saves its clients (plan sponsors) money by negotiating discount rates with pharmacies and influencing doctors to prescribe cheaper, but still therapeutically appropriate, medicines. When a customer buys drugs at a local pharmacy, the pharmacist checks with Medco to ensure that the customer is an approved beneficiary. Then the customer makes a co-payment—usually between $5 and $15—which goes directly to the pharmacy, not to Medco. Although Medco did not handle these co-payments, it interpreted the accounting standards to allow it to recognize the co-payments as revenue.2 But it did not disclose this revenuerecognition policy. In fact, Merck’s 1999 SEC Form 10-K stated that Medco recognized revenue “for the amount billed to the plan sponsor.” After Merck changed auditors, and before it began filings for the Medco IPO, it changed this language in its 2001 Form 10-K to state that revenues were “recognized based on the prescription drug price negotiated with the plan sponsor.” Merck’s April 17 Form S-1 disclosed for the first time that Medco had recognized as revenue the co-payments paid by consumers, but it did not disclose the total amount of co- 2 Merck apparently subtracted out these co-payments later, so its profit numbers were unaffected by this policy. 5 payments recognized. The day this S-1 was filed, Merck’s stock price went up $0.03—from $55.02 to $55.05.3 Merck filed an amendment to its S-1 on May 21 and another on June 13. On June 21, 2002, The Wall Street Journal reported that Medco had been recognizing co-payments as revenue and estimated that in 2001 $4.6 billion in co-payments had been recognized. Barbara Martinez, Merck Included Co-Payments Among Revenue, Wall St. J., June 21, 2002, at C1. Later disclosures would show the actual number to be $5.54 billion. The market’s reaction was immediate; that day Merck’s stock lost $2.22—dropping from $52.20 to $49.98. Six days later, Merck announced the postponement of the Medco IPO and indicated that it would drop Medco’s offering price. Merck filed its fourth S-1 on July 5, 2002, finally disclosing the full amount of co-payments it had recognized as revenue. The S-1 showed that Medco had recognized over $12.4 billion dollars in co-payments as revenue, $2.838 billion in 1999, $4.036 billion in 2000, and $5.537 billion in 2001. Four days later, Merck announced that it would postpone the Medco IPO indefinitely, even as it filed its last S-1, which was 3 We can take judicial notice of Merck’s stock prices even on a motion to dismiss because these facts are “not subject to reasonable dispute [and are] capable of accurate and ready determination by resort to a source whose accuracy cannot be reasonably questioned.” Ieradi v. Mylan Labs., Inc., 230 F.3d 594, 600 n.3 (3d Cir. 2000). 6 approved by the SEC. Merck’s stock continued to fall, reaching $45.75 on July 9, the end of the class period, and $43.57 on July 10.