Revenge of the Shorts at Biovail

Call it the revenge of the shorts, for last week was not a happy one for Eugene Melnyk, the chairman of Canadian pharmaceutical manufacturer Biovail (BVF). The first shoe dropped on Monday, when the Ontario Securities Commission, in a long-anticipated action, charged him and several associates with using Cayman Island trusts to avoid trading disclosure requirements.

And, because shoes come in pairs, Melnyk took another kick Wednesday, when the market unkindly wiped 25 percent off Biovail’s market cap on the back of a Californian federal court ruling on patents relating to Wellbutrin XL, which accounted for more than 35 percent of Biovail’s 2005 revenues.

In February, Melnyk (pictured) sued the regular suspects – including, but not limited to, Steven Cohen’s SAC Capital, research house Gradient Analytics, and sundry other individuals and corporate entities – for $4.6 billion, alleging a “massive and fraudulent disinformation campaign” and other actions intended to drive down the price of Biovail’s stock.

But the OSC’s formal statement of allegations, released Jul. 31, suggests that Melnyk and several business associates had grabbed a page or two from the Wyly playbook that was disclosed by the US Senate Permanent Committee on Investigations on Aug. 1.

According to the OSC, Melnyk in 1996 transferred the ownership of more than four million Biovail shares, representing approximately 19 percent of Biovail’s outstanding shares at the time, to four Cayman Islands-domiciled trusts; Melnyk was the settlor of the trusts and listed, along with family members and “certain friends,” as a beneficiary. The same year, trading accounts were opened at various Canadian and US brokerages for Caymans investment companies that held the trust assets, which “primarily consist of Biovail shares.”

The 31-page report summarizes extensive trading in Biovail common shares and call options in 2002-2004, alleging that Melnyk approved or directed those transactions, communicating with “certain trustees and/or registered representatives at the Canadian and US brokerage firms…either directly or through his assistant.”

As well, between Apr. 1998 and Dec. 2003, Melnyk received loans now totaling over $100 million, including accrued interest, from the trusts “Melnyk directed that…Biovail common shares be sold to generate sufficient proceeds in order to fund the loans. At other times, Melnyk requested loans from the trustees and knew or should have known that the Trustees were required to sell Biovail common shares in order to fund the loans.”

While not accusing Melnyk of insider trading, as such, the OSC alleges that Melnyk repeatedly breached Ontario securities law by failing to file required insider reports in respect of the numerous trades in Biovail stock in 2002-2004, and failing to publicly disclose his complete holdings, and changes in those holdings. As well, he allegedly failed:

After the introduction of new rules in 2004, to “file an insider report disclosing the existence and material terms of the trust arrangements…”

To issue and file early warning press releases and failed to file early warning reports disclosing the securities held by trusts, and related information.

To comply with control block distribution rules, because the stock held by the trust, along with his other holdings, “formed an aggregate of over 20 percent of the outstanding common shares of Biovail.”

To disclose the full extent of his holdings in 2002 and 2003 management proxy circulars; the 2002 circular disclosed that Melnyk held 16.7 percent of Biovail, although his total holdings, including the trust assets, exceeded 25 percent. A similar discrepancy occurred in the 2003 circular. “Similarly, Melnyk has failed to provide complete and accurate information to Biovail…in relation to Biovail’s 2004, 2005 and 2006 Circulars.”

The OSC also alleges that Roger D. Rowan, a director of Biovail from 1997 to 2005, traded stock in the Melnyk accounts during blackout periods. As well, it alleges that Watt Carmichael – the brokerage where Rowan is president and chief operating officer – and Rowan “materially misled” both the staff of the Investment Dealers Association – Canada’s NASD equivalent – during a 2000 investigation, and OSC staff conducting the investigation that led to the current allegations.

The OSC has scheduled a hearing for Sep. 21 to consider sanctions that would prohibit Melnyk from trading Biovail stock at least until he meets past and current disclosure requirement; force his resignation, and prevent him becoming an officer or director of any issuer; pay administrative penalties of not more than $1 million for each violation of Ontario securities law; and pay costs.

Both Rowan and Melnyk strongly denied wrongdoing. Melnyk released a statement disputing the OSC’s staff contention that he had legal control or direction over the shares in the trusts and was required to file reports concerning them. “I intend to pursue the swiftest possible resolution of this matter in order to demonstrate that I took my reporting obligations seriously and that I complied with those obligations in every respect,” he stated.

“I have always conducted my personal and business affairs with the highest degree of honesty and integrity.”

The OSC trading disclosure action addresses just one aspect of the regulatory challenges facing both Biovail and Melnyk; both the US Securities Exchange Commission and the OSC are continuing investigations into Biovail’s accounting and disclosure practices.

Additional reading
Ontario Securities Commission v. Eugene N. Melnyk, Roger D. Rowan, Watt Carmichael Inc, Harry J. Carmichael and G. Michael McKenney
Statement Of Allegations Of Staff

Notice of hearing (includes recommended sanctions)

Eugene Melnyk Responds to OSC Notice of Hearing
PR Newswire Jul. 31 2006

Eugene Melnyk's Attorney Corrects Inaccurate Media Reports
PR Newswire Jul. 31 2006

Melnyk case seen as tough for OSC to prove
Legal expert says there's 'big hill to get up'
by Janet McFarland
The [Toronto] Globe & Mail Aug. 1 2006

Earlier coverage by Greg Newton
Biovail’s assault has a familiar ring
Feb. 24 2006

Biovail Stock Manipulation Case Runs On
Mar. 27 2006