NEWSWEEK AUGUST 24 1998
SHERLOCKS OF FINANCE
Accounting shenanigans are on the rise, creating a bull market for some eagle-eyed scam spotters
By Daniel McGinn
YBM Magnex was the kind of whisper-in-your-ear stock that keeps folks clicking on financial Web sites. For more than a year on-line tipsters traded news about the magnet maker listed on Toronto's stock exchange. Then Adrian du Plessis put YBM under his microscope. Where boosters saw a sure thing, du Plessis, a self-employed researcher who exposes dubious stocks, saw signs of trouble. In March he published two stories pointing out how auditors had made YBM revise its sales numbers, and that two of its directors had been implicated in an earlier alleged scam. The company angrily denounced his work. But two months later, after auditors raised more red flags, FBI agents raided YBM's headquarters amid allegations of money-laundering and ties to reputed Russian mobsters. YBM's stock, worth $14 before the raid, hasn't traded since; the Feds are still poring over evidence. And du Plessis is thrilled.
YBM is the most exotic tale from a year in which "accounting irregularities" have become all too regular. Accounting scandals have cost "Chainsaw" Al Dunlap his job at Sunbeam and wreaked havoc at Cendant; last week the plague hit Broadway powerhouse Livent. Experts say the blizzard of funny numbers is largely a phenomenon of an aging bull market: to keep stocks (and the value of executives' stock options) rising, some firms are tempted to fudge figures to meet analysts' expectations. Last week the Securities and Exchange Commission held meetings to study the issue. For now, though, this is a golden age for the self-styled scam spotters who pride themselves on identifying tomorrow's scandals today. While du Plessis dominates this arena in Canada, the U.S. market is ruled by Howard Schilit, a former accounting professor who called attention to Sunbeam and Cendant before their problems came to light.
Du Plessis is a most unlikely financial watchdog. The son of a CPA, he grew up in Vancouver and later dropped out of high school to manage punk-rock bands. When punk faded he migrated to the Vancouver Stock Exchange as a floor trader. His go-go years ended in 1986, he says, when his bosses asked him to manipulate stocks. He blew the whistle and began a career as a freelance muckraker; in the last decade he's written a book on stock scams, researched another on the Bre-X fraud and uncovered a dozen stock scandals that have helped earn his hometown the nickname "Scam Capital of the World." Today the 39-year-old lives on a secluded island off the coast of Vancouver, earning a meager living researching books, serving as an expert witness and running his Web site (www.imagen.net/howenow). Admiring journalists and securities lawyers praise his obsession with uncovering the truth, his encyclopedic knowledge of stock scams and his uncanny ability to find fraud. "It's an amazing process," says John Woods, publisher of Canada Stockwatch, which printed his YBM stories. "He just has to see a piece of paper, a press release, an analyst's report. He almost just brushes up against a file and the dirt sticks to his hand." Du Plessis says many scams involve the same players and tactics. "All I've been doing for years is refining the same techniques," he says. "The game doesn't change -- only the decimals do."
Even for a veteran scandal spotter, the tale of YBM Magnex holds particular intrigue. YBM, which makes magnets and bicycles, was formed through the merger of companies in Canada, the Channel Islands and Hungary; one of those firms was founded by Semeon Mogilevitch, a reputed Russian mobster. Du Plessis wasn't aware of that link when he began researching YBM -- the accounting red flags and two directors' questionable pasts drew his attention. But after auditors refused to sign off on YBM's 1997 books and raised the possibility of "illegal acts", the Feds moved in. Although investigators are mum, they're apparently looking at whether YBM's sales are being used to launder mob money. YBM insists Mogilevitch isn't involved in managing the firm and that its own investigation found no criminal activity.
Howard Schilit hunts bigger prey than YBM, dissecting financial statements from blue-chip companies like United Health Care, 3M and Oxford Health Plans. Unlike du Plessis, he's not looking for outright fraud; rather, he identifies "early signs of operational deterioration," particularly by zeroing in on aggressive accounting moves that might camouflage a sagging business. Although Schilit, like du Plessis, doesn't buy or sell stocks based on his research, his efforts are explicitly designed to aid investors. His clientele of institutional investors -- a third of them short-sellers, who bet on stocks to fall -- pays more than $10,000 a year for Schilit's monthly newsletter on companies with questionable accounting. Showing up on that list usually foretells trouble: the average stock price of the companies Schilit highlighted in the last year is down 26 percent. "Howard identifies problems that conventional Wall Street analysts don't pick up on," says one hedge-fund manager. Although most companies quietly weather Schilit's criticism, a few emerge to become full-fledged scandals. "Sometimes when you see unusual accounting, that may be the tip of the ice-berg," he says.
Two cases in point: Cendant and Sunbeam. Cendant was formed last December from the merger of two companies, HFS Inc. and CUC International. As far back as 1994, Schilit was questioning how CUC, a shopping service, accounted for acquisitions. "We were poking around in the right neighborhood," he says, though he had no clue of the alleged massive fraud -- involving artificially inflated revenues -- that's come to light this year. The trouble at Sunbeam follows that pattern, too. Last December Schilit's researchers flagged the appliance maker for apparently shifting expenses from one quarter to another to pad results. This summer chairman Dunlap was fired amid similar allegations that Sunbeam had pushed barbecue grills into stores before the end of 1997, effectively booking revenue it shouldn't have.
Schilit longs for a time when his work causes accountants to think twice before allowing these tricks. "If your business is healthy and you're honest and competent, the last thing you want to do is play games with your accounting," he says. Du Plessis, too, hopes his work might stem the flow of dubious deals that have marred the reputation of Canada's stock markets. For him this is a bittersweet time: after YBM, he's afraid he's unraveled the best mystery he'll ever find. He muses that he might turn off his computer if given a chance to become a roadie for Sheryl Crow. Colleagues doubt it. "He probably has a couple of dozen (companies) in his cross hairs now," says Diane Francis, editor of The Financial Post, Canada's business newspaper. Pray they're not in your portfolio.
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