Tips for the Timid: How to Detect Financial Fraud and Other Stock Shenanigans
By Herb Greenberg
Senior Columnist
2/11/00 10:40 AM ET
No matter how often I write about financial fraud and other stock-related troubles, readers tell me they want tips on
how to find it -- or least how to spot companies that might be having trouble. The requests for tips come from money
managers (believe it!) as well as from individual investors looking for an edge. What to look for? This is the first of
what I hope will be a regular series of columns that will help give you perspective and avoid getting blindsided. In the
future, I'll take you back to how I stumbled on some of my best "hits" and why I stuck with them even when readers
were demanding that I be fired.
For a jumping-off point, let's go to the New York Hilton. That's where I was Wednesday, sitting on a panel with
accounting sleuth Howard Schilit of the Center for Financial Research and Analysis; attorney Alan Schulman of
Bernstein Litowitz Berger & Grossman, who files class-action lawsuits against companies; and Boris Feldman of the
Silicon Valley law firm Wilson Sonsini Goodrich & Rosati, who defends the companies that Schulman sues. The title
of the panel was "Detecting Financial Fraud From Publicly Available Sources."
Herb's Latest: Join the discussion on TSC message boards.
Our audience was 500 insurance carriers and brokers at a gathering sponsored by the Professional Liability
Underwriting Society. These aren't your usual insurers; these are the folks who insure corporate directors and officers
against claims of fraud. As you might guess, their incidence of claims is increasing at a disturbing rate.
So, did I tell them to go before they write a policy?
My top 10 list:
I would look at Baseline, Bloomberg or even the "upgrades and downgrades" section under company profiles on
Yahoo! Finance (YHOO:Nasdaq - news). You're looking for analysts who have a sell or hold rating on a stock that
most others rate a buy. Analysts don't usually veer from the comfort of the herd if they don't have a good reason. Try
to get the reports free from the brokerage firm or, for a fee, from a service like Multex (www.multex.com).
Remember when Lucent (LU:NYSE - news) was popular? As reported here a year ago, two analysts had holds on
it; today they look like geniuses.
Check short interest, which you can find every month in the Tools section of TheStreet.com and under company
profiles on Yahoo! Finance. Short interest, in and of itself, doesn't necessarily mean anything. But it does suggest
people are betting against a company. You want to find out why, especially if short interest is expanding. (And don't
listen to the sell-side analysts who will pooh-pooh any of the negatives on a company from which they're trying to get
investment banking business.)
If the company does have a large short interest and the CEO has waged a public war against the shorts and the
company's critics, sharpen your pencil. This is almost always a sign of desperation. It was CHS Electronics
(HS:NYSE - news) CEO Claudio Osorio who publicly declared war on short-sellers of his company's stock. That
was in June 1998, when CHS stock was around 25; it's now around 1 1/2.
Regardless of what I said above about the sell-side analysts who like the company, do get their reports, and do what
I do when I research stocks for the Stock Drill segment on "TheStreet.com" show on the Fox News Channel: I zero
in on what they declare to be the risks. It was there that I found some concern for credit-card-related problems at
Bank One (ONE:NYSE - news) -- the same credit-card problems that wound up dragging Bank One down.
I would do a scan of any of the company's filings with the Securities and Exchange Commission. Here I'm talking
about 10-Qs, 10-Ks, S-1 filings and amendments. Then I would go to Microsoft Word and use the compare
function. (See my column here from a few months ago explaining how that works.) I would compare the actual text in
the risk factors and the management discussion and analysis sections. And, just for the fun of it, see how the wording
has changed. This led lots of folks to realize that 3Com (COMS:Nasdaq - news) was headed for trouble years ago.
I'd hire a forensic accountant to do the numbers, or I'd subscribe to a service like Howard Schilit's.
Then I would check to see if journalists like me, who specialize in talking to the short-sellers, have written about a
company in which you're interested. I talk to some really smart short-sellers, and when they're right, which is often, I
always ask myself why it was that the short-sellers knew and nobody else did. The short-sellers, for example, knew
that The Learning Company was aggressive with its books for years -- years before it was bought by Mattel
(MAT:NYSE - news). I've written it for years. And after Mattel acquired TLC, I suggested in one of my columns
that it would only be a matter of time before Mattel learned TLC's dark and dirty secret.
Look for a revolving door of CFOs. And if the company is losing CFOs or other top execs, with any frequency, you
might want to check local courts for any wrongful termination suits. Years ago, I was tipped off that a former CFO of
Supercuts, the haircutting chain, had filed a wrongful termination suit against the company. It was full of all kinds of
allegations. Turns out his predecessor did the same. That company eventually crashed and burned, and the CEO was
kicked out.
Check out the message boards on Yahoo! or elsewhere. The more zealot-like they are, the more careful you should
be.
Finally, ignore the direction of the stock. Don't let it give you a false sense of security. Back in the mid-1990s, when a
company called Media Vision had the hottest stock in Silicon Valley, I had written numerous columns questioning the
company. After one especially blistering take, the CEO called said something like, "A-ha, our stock is rising. It shows
your short-selling friends are wrong." Media Vision wound up filing for bankruptcy, and the ex-CEO is now awaiting
trial on securities fraud charges.
Questions, comments, criticism? Let me know. And if you care to share thoughts on how you spotted trouble, pass it
along. I'd especially love to hear from money managers who can give examples of what caused them not to buy a
stock that eventually cratered. |
