Walgreens, Executives Sanctioned By SEC For False Projections
The Commission has been bringing an increasing number of cases involving models and statistical analysis. Those cases have ranged from cherry picking actions involving investment advisers who disproportionately allocate losing trades to clients and profitable ones to themselves as demonstrated by a statistical analysis to the use of untested models in the absence of implementing appropriate procedures to monitor them. See, e.g., SEC v. World Tree Financial LLC, Civil Action No. 18-cv-1229 (W.D. La. Filed Sept. 18, 2018)(cherry picking); In the Matter of Aegon USA Management, Adm. Proc. File No. 3-18681 (August 27, 2018)(untested models not properly supervised). The Commission’s latest action involving models centers on the use of a model built on assumptions to give the market long range guidance that was repeatedly reaffirmed despite adverse events undermining the projection. In the Matter of Walgreens Boots Alliance, Inc., Adm. Proc. File No. 3-18850 (Sept. 28, 2018).
Named as Respondents are: The firm, the product of a merger between Walgreen Co. and Alliance Boots, GmbH, a European pharmacy-led health and beauty firm in a two step merger announced on June 19, 2012; Gregory Wasson, the former CEO of Walgreens; and Wade Miquelon, the former CFO of the firm.
When the merger was announced in June 2012 Walgreens announced 2016 goals that were composed of financial metrics the company planned to track going forward. Key was a projected Goal for FY EBITA of $9.0 to $9.5 billion.
Walgreens intended to provide quarterly reaffirmations of the goals, if reasonable. The Goal was calculated using a “deal model” formulated by Walgreen’s M&A team and outside advisers. The model forecast baseline FY 16 EBIT of $9.9 billion with a “severe downside case” of about $9.3 billion. The firm derived the FY16 Goal after reducing the deal model’s baseline forecast by $900 million of corporate contingency to cover unexpected risks.
The deal model used was based on the FY 2013-2015 long range plans or LRP for the Walgreens – Alliance Boots base businesses, along with an assumption for the synergies anticipated from the merger. Since neither company had long range plans going out to 2016, the model adopted growth assumptions to extrapolate out to 2016. At the time Walgreens was engaged in long range planning but had not obtained Board approval for a long range FY 2013-2015 plan to which it could apply the growth rates for 2016.
The FY16 EBIT Goal was deliberately challenging. Internally it was referred to as “challenging, stretch goals.” Walgreens used the word “goals” in its proxy to describe “challenging yet achievable” targets.
In October 2012 Walgreens’ Board approved its FY 2013-2015 LRP. Management also presented the Board with what it called a “Glide Path to Stated Goals.” It contained interim targets for fiscal years 2013, 2014 and 2015. Those interim goals built toward the ultimate 2016 goals.
As the firm moved forward and developed its long range plans it repeatedly reaffirmed the FY16 EBIT Goal despite continued indications that it was not achievable. For example:
· During the LRP process in 2013 Walgreens’ internal forecasts lagged expectation, suggesting difficulties in achieving the FY16 goals. In early July 2013, when its preliminary FY 2014-2016 LRP was presented to the Board, it showed gaps to each of the interim targets in FY 2013-2016 and FY16 EBIT $400 million below the low end and $900 million below the high end of the Goal.
· In October when the final LRP was presented to the board and approved the forecast for FY16 EBIT remained $300 million below the low end, and $800 million below the high end, despite the fact that $500 million of contingency had been released.
· By November 2013 the firm recognized additional risks to reaching the FY16 Goal. Unanticipated levels of inflation in the price of generic drugs was present resulting in a reduction in its internal FY16 EBIT forecast. Thus, by December 2013 the firm was internally forecasting FY16 EBIT of $8.4 billion after the release of the $500 million corporate contingency.
· By early April 2014 Walgreens Board was provided with an updated forecast. It called for FY16 EBIT of $8.4 billion after the cumulative release of $600 million of corporate contingencies. And, by May 2014 the FY16 number had declined to $7.5 billion.
Yet until the third quarter 2014 the firm continued to reiterate the original projection, although it admitted reaching the goal was challenging. Ultimately at the firm’s June 2014 earnings call (the third quarter for the firm) the company withdrew its 2016 goals. Yet in quarterly discloses made in June 2013, October 2013, December 2013 and March 2014 the firm had reiterated the original projection despite having substantial information internally to the contrary. An announcement resetting those goals was made the next month. The stock price dropped 14.3% following the announcement. The Order alleges violations of Securities Act section 17(a)(2).
To resolve the proceedings each Respondent consented to the entry of a cease and desist order based on the section cited in the Order. The firm will pay a penalty of $34.5 million. Each executive will pay a penalty of $160,000.