YBM Magnex: Securities Industry Due Diligence in a post-Bre-X Market - Part 3 - Business as usual...
There's a quaint myth -- still surfacing on occasion, like the Ogopogo creature in British Columbia's Lake Okanagan -- that Canada's stock markets are governed according to such bedrock principles as "full, true and plain disclosure."
Stock exchange policy manuals traditionally advise that public companies are supposed to issue press releases that are "factual and balanced, neither over-emphasizing favorable news nor under-emphasizing unfavorable news." There is supposed to be timely disclosure of any "developments relating to the business and affairs of the company that would reasonably be expected to significantly affect the market price or value of any of the company's securities or that would reasonably be expected to have a significant influence on a reasonable investor's investment decisions."
But, like the Sasquatch, or Ogopogo (Canada's version of "Nessie", the Loch Ness monster), clear examples of market principles being enforced are rarely sighted.
The unusual press releases issued by Pratecs/YBM Magnex in June and July of 1995 failed to indicate, fully and plainly, the nature of underlying events for a reasonable investor. And, experience shows, when a public company obscures the nature of some event or the identity of any parties, those will usually prove to be details worth knowing.
The company's oblique wording, supposed to explain the basis for a six-week halt in share trading, was hardly an exemplar of "full, true and plain disclosure." It left me, as a member of the public, wondering: just what were the unspecified allegations?; and precisely who were the unnamed parties against whom these unspecified allegations had been made?; and exactly who was making these unspecified allegations against unnamed parties?; and could these unspecified allegations against unnamed parties made by unidentified parties potentially influence a reasonable person's investment decision in Pratecs/YBM?
In short, what the hell was going on in London, England that the company's management wasn't telling the public?
Finding absolutely nothing in the brokerage research reports I'd gathered that would shed any light on this highly questionable situation, I began the process of searching for clues on the public record about YBM's subsidiary, Arigon. A couple of calls were placed to London, England - kick-starting court and corporate registry searches. The Canadian filings of YBM/Pratecs were ordered from the Alberta Securities Commission (which will sell anybody, even brokerage analysts and mutual fund managers and/or advisors, a microfiche file on any Alberta-listed company for only CDN $10.00 plus $0.70 GST.)
The public was informed by Pratecs/YBM in its July 1995 announcement that Arigon's unnamed legal counsel had confirmed that the unspecified allegations against unnamed entities made by unidentified parties were "unsubstantiated."
That might be enough to satisfy Canada's provincial securities regulators, but, to an experienced observer of junior, or small-cap, stocks this sort of disclosure appears more alarming than a stack of cheer-leading research reports churned out by senior Bay Street brokerage houses.
YBM Magnex had reported incredible growth since its 1995 beginnings as an ASE-listed shell. Little more than two years after trading for pennies a share, this magnet-bicycles-oil-and-more company was well on its way to the billion dollar market cap level and, yet, right from its inception as a public company there existed serious, unanswered, questions.
While waiting for some answers to return in the form of public record files from London and Edmonton, I carried on with my review of the company's history as outlined in Canada Stockwatch.
(For the purposes of maintaining narrative flow, a fuller chronology of the YBM Magnex history and contextual elements will be described later in this multi-part series.)
One of the first brokerage analysts to publicly endorse YBM Magnex stock was Rob McConnachie. McConnachie started pitching YBM when he was employed by Canaccord Capital and carried on touting the company and its stock when he moved to Scotia Capital Markets in early 1997. I'd had opportunity to fact-check some of McConnachie's work in 1994 - when he was turning out reports for a different employer, the now-defunct boutique Marleau Lemire Securities.
As noted in considerable detail elsewhere on the Investigative Research & Analysis web-site (@ imagen.net ) in those days McConnachie was keen on a scandalous ASE and Amex-listed company called Cycomm International Inc. He put his name to a research report which failed to note Cycomm's continuing history of making misrepresentative and false public statements, its lengthy involvement with an ex-convict inventor, its trumpeting of non-existent products and other troubling elements. Instead, the MBA analyst focused upon what he saw as extremely favourable prospects for growth in Cycomm's revenues and profitability (which, naturally, failed to materialize). When questioned by the B.C. Securities Commission as to its dubious content, Marleau Lemire claimed McConnachie's boosterish report had not been damaging to investors since the brokerage was aware of its inaccuracies and failings and had not released it to the public.
Along with brokerage industry supporters such as Rob McConnachie, YBM Magnex was attracting mutual fund players including Steven Misener, described admiringly in print by fund-guide writer Gordon Pape as a "rumpled, articulate portfolio manager" at BPI Capital. In 1996, in the wake of personal trading scandals involving Canadian mutual fund gurus Veronika Hirsch and Frank Mersch, I'd had occasion to research one Vancouver penny stock, Serengeti Diamonds Ltd., in which, a few years earlier, Misener family members had invested in advance of, and alongside, BPI mutual funds managed by their rumpled, articulate, relative.
Unlike those cases brought to public light involving Altamira's "rock star" Mersch and AGF/Fidelity's "diva" Hirsch, the Serengeti units and shares which Steven Misener's family and friends purchased did not enjoy the good fortune of benefiting from a price boost following the fund's participation. That's the nature of the junior stock market - not every deal can be a winner, even temporarily. And, unlike those celebrated cases involving fund managers' personal share dealings, the Misener group activities were never publicized.
In any event, questions about possible conflict of interest and/or appropriation of opportunity may not have arisen in the case of Serengeti Diamonds as Steven Misener had, in apparent hindsight, the foresight to not purchase any shares.
In June 1994, Serengeti announced a private placement of two million units (one share + one share purchase warrant) priced at $0.45 each. A group of fund manager Misener's friends and family members, including his sister and brother, picked up 133,000 units in aggregate. The certified filing for this placement was dated September 12 1994 and the units were approved for issuance by the Vancouver Stock Exchange on September 14 1994.
On September 13 1994, following up on a public announcement of the previous week, Serengeti filed a notice with the VSE concerning another private placement. This time, the company was going to issue 586,000 units (one share + one-half share purchase warrant) at a price of $0.55 each. The company disclosed that 550,000 units were being purchased by BPI Financial Corporation, "a public company listed on the Toronto and Alberta Stock Exchanges", and 36,000 units were being bought by Steven Misener, "a Senior Vice President of BPI."
On September 28 1994, Serengeti wrote to the VSE further to its September 13 filing and explained: "Subscriber Steven Misener has reconsidered his investment. As an officer of the fund which is the other investor, he believes it is best not to participate in his private capacity." The company went on to state that another investor had been located and it sought the VSE's approval for the replacement of Misener as subscriber with the new party that had come forth, Florence Jucker.
On October 25 1994 the VSE approved the issuance of units in this second Serengeti private placement - with BPI (on behalf of its Canadian Small Companies Fund) buying 550,000 units as originally disclosed, and the balance of 36,000 units being picked up by the other investor that had been located in place of Steven Misener. Nowhere on the VSE's public record was it noted, however, that Florence Jucker had another role - that of being Steve Misener's mother.
Despite his faith in the deal, and his mother, brother, sister and others close to him riding it, Serengeti failed to perform as Misener may have liked. After flat-lining at the $0.65 level in October 1994, Serengeti's shares began to slide and the company's lack-lustre African diamond and gold exploration was no cure.
By October 25 1995, when Serengeti announced another private placement -- of which the BPI Canadian Opportunities RSP Fund (co-managed by Misener) acquired 750,000 shares (and Prudential Insurance bought another 750,000) - the price of this VSE small-cap stock had slipped to $0.20.
Possessing this sort of historical knowledge about those industry players in the orbit of YBM Magnex, such as analyst Rob McConnachie and money manager Steve Misener, can be interesting but the most valuable due diligence material is that which directly concerns the company and its origins, principals and activities. The fact that McConnachie previously issued a bullish report on a scam company and that Misener felt it was inappropriate for himself - and his mother was found instead -- to invest alongside his funds (following his siblings' lead) may say more about the standards of the Canadian securities industry as a whole than it does about YBM.
So, after letting my mind wander through such other amusements as are to be found in Bay Street and Howe Street research, I returned to considering the particular company file at hand. The public record as contained in Canada Stockwatch suggested that YBM Magnex had an uncanny knack for meeting or exceeding earnings and profit projections.
The last company I had investigated that was so able to repeatedly excite analysts by its pre-ordained-like growth was the Indonesian gold explorer Bre-X Minerals Ltd. In that case, tragically, the public eventually learned that the company was well able to meet or exceed its progressive targets by fabricating the results.
When sports legends like baseball hall-of-famer Babe Ruth pointed to the exact spot in the stands he was to hit a homer, or ice-hockey's powerhouse Mark Messier predicted a victory in a key game in his team's Stanley Cup quest and then made it happen, these were seen as rare and special events. If someone in sports was able to predict the outcome of almost every game or race or forecast the points total of each match, one would quickly suspect something was rigged.
In the world of Canadian stocks, however, when a junior company performs astounding financial feats on cue it may be no cause for alarm. Bay Street analysts appeared reassured, rather than concerned, by YBM's continuing ability to improve its numbers at a phenomenal rate. Another achievement lauded by the securities professionals was the ability of YBM's stock price to continually meet or exceed the securities analysts' own share price targets. Under such circumstances everyone looks smart and can boast, proud of their crystal balls.
Between 1993 and 1996 the company had reported compound annual revenue growth of about 63% and claimed a compound earnings growth of rate of some 31% per year. Carrying this trend further, Mike Middleton, an analyst for Griffiths McBurney & Partners projected for YBM Magnex a net income increase of 44% in 1997, 30% in 1998, and 23% in 1999.
How could an upstart venture with murky origins, competing in an established industry, become such a sensational money-spinner virtually over-night? The answer was not evident from reading the brokerage analysts' reports, nor was it evident from examination of the backgrounds of those YBM Magnex principals with a public company track record in Canada.
In late 1997 and early 1998 the company made references to an unqualified audit that had been performed by Deloitte & Touche. An independent audit carried out at the behest of provincial securities regulators was not a common event - but, somehow, this yellow flag flashed green in the eyes of the Bay Street money merchants.
On February 3 1998, analyst Kaan Oran, then with First Marathon Securities, stated that YBM Magnex had come out of this "forensic study. with flying colours." At the same time Oran was gushing in research reports and to the press, a vice-president of First Marathon, Robert Owen Mitchell, was a director of YBM Magnex - having become an insider of the company on January 26 1996 (exactly three months after Mitchell certified, on behalf of First Marathon, a YBM prospectus as constituting "full, true and plain disclosure of all material facts").
Just like cheer-leading research reports that show a lack of intelligent, and independent, due diligence, and mutual fund managers and/or advisors with questionable proximity to their small-cap picks, the sight of a brokerage house analyst touting a stock that could benefit a senior executive at the same firm is not something that is out of place in Canada's financial community.
While such a situation may be par for the course on Bay Street, rather than just take Kaan Oran's word for it, I thought I'd see for myself how eminently YBM had passed its audit by Deloitte & Touche.
I refilled my coffee-mug with water and logged on to the free-access SEDAR regulatory filing site (@ sedar.com ).
End of Part 3
For more on this story and other stock market news and analysis, visit the Investigative Research & Analysis web-site at imagen.net
Marcos - yes, after the Bre-X and YBM scandals, the TSE appears to looking for more PR trouble!
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