YBM Magnex: Securities Industry Due Diligence in a post-Bre-X Market - Part 4 - Off the beaten track
With the popularization of the internet, it's becoming increasingly simple to build one's own due diligence, or research, file on any Canadian public company from any remote location - as long as you have power and a telephone line. At the same time as it's becoming possible to study an investment prospect from, say, a computer terminal on-site in the jungles of Borneo, it appears that the capacity for independent research may be being lost, or, at least, overlooked, by some professionals operating in the corporate jungles of Bay Street or Howe Street.
In addition to those web-sites that offer free access to filings of North American public companies (such as SEDAR @ sedar.com and EDGAR or SEC filings at @ sec.gov ) there are sites that offer corporate and other related data for a fee (such as Canada Stockwatch @ canada-stockwatch.com) and numerous choices for data on corporate registrations, legal cases and judgements etc. (including Lexis/Nexis @ lexis-nexis.com ). And, in addition to on-line news-services that cover almost every populated geographic location, there are internet newsgroups and discussion groups that sometimes help to gather and focus this world of on-line information within the confines of a stock market context. Sometimes these groups just provide entertainment value. Sometimes, not even that.
By far the most popular internet chat forum is Silicon Investor (@ 3.techstocks.com ). On a Silicon Investor, or SI, discussion "thread" one may encounter members of the public who are so well-informed, and enthused, about a favourite company's prospects that their words can be more valuable to study than those uttered by the company's own PR or investor relations flak. That holds for whichever way you view them - as electronic sages or as wired shills.
Bre-X Minerals Ltd., for example, the best known Canadian stock ever to become a hot topic of discussion on SI, enjoyed the on-line attentions of Merrick Walsh, brother of the late Bre-X chief, David Walsh. During a critical stage of Bre-X's public life, Merrick Walsh, posting under the pseudonyms "drumbeat" and "mikesloan", waged an avid campaign for the hearts and minds of investors.
Before the Bre-X gold fraud was publicly exposed, Walsh worked relentlessly to attack naysayers on the internet discussion threads and to encourage, or reassure, investors in his brother's company's stock. Once the Busang swindle was publicly exposed - with some finality - in May of 1997, Walsh kept busy steering criticism away from Bre-X's Calgary office and consistently praising his brother's qualities of leadership and integrity.
"drumbeat" Walsh made his first SI posting on January 22 1997 during the heat of the battle for Busang then being waged by Placer Dome and Barrick (and eventually "won" by Freeport McMoRan) - and one week before fire destoyed the geology room of Bre-X's PT Westralian Atan outpost in Indonesia thereby signalling that the scheme was near unravelling.
Some of the first words that Merrick Walsh shared with the on-line community offered this insight about his brother, David: "Mr Walsh doesn't talk very often but listen very carefully when he does." The upbeat "drumbeat" later added more nuggets of wisdom to, or created a toxic tailings dump on, the SI archives: "The most important person in the gold-digging business is David Walsh," said his brother on February 18, 1997. That same day he noted: "What a great time to buy!!!!" The next day he contributed: "Don't be fooled into selling your (Bre-X) stock. I'm sure it will not be at these prices for long." On February 21 he commented: "Without Mr Walsh we would probably have nothing right now. the only mistake Bre-X made was to find too much gold."
By March 23 1997 Merrick Walsh had dropped his handle of "drumbeat" and was posting under a different pseudonym -- "mikesloan." By this date, the literal and figurative Bre-X "fall guy", Philipino geologist Mike de Guzman, had apparently plunged to his death from a helicopter and an Indonesian news report had questioned the existence of a mineable gold deposit at Busang. For David Walsh's brother, it was time to take off the gloves - if not the mask - and taunt, "come on, Freeport, step up and be counted. Let's have a public statement saying the deposit is worthless if that's what you think. I double-dog dare you to CANCEL THE DEAL!!!" His dogged support for his brother never flagged: "Mr Walsh is competent and brilliant and is ferreting out the truth." As late as April 29 1997, Merrick Walsh AKA "drumbeat" AKA "mikesloan" was telling whoever would listen on Silicon Investor: "When all the gold is discovered at Busang it will exceed most people's wildest expectations."
On May 4 1997 the interim report of Strathcona Minerals was released to the public and confirmed that the Busang gold deposit was a fraud. After months of advising people on-line to hold onto their Bre-X stock or to buy more shares, Merrick Walsh found a new edge. On May 21 he chastised one Bre-X victim: "Get a grip man. let's start taking some responsibility for our actions and stop trying to blame someone else for our own mistakes. Bre-X's Calgary management or staff did nothing wrong." By May 22, things were a little nastier, as Walsh dedicated this message to Michael de Guzman's brother: "Shut your mouth jerkface!!!!!" On July 9 "mikesloan" posted to SI that a CBC cameraman, Mark David Fuller, had "been charged with assault against Brett Walsh (David's son and a Bre-X employee). Let's hope this makes the front page." An understandable sentiment for an uncle, perhaps.
Brother/uncle/investor/netizen Merrick Walsh carried on with his Silicon Investor chatting - on some days making dozens of postings - until July 29 1997 when he was "outed" by others on the Bre-X main discussion thread who had grown increasingly irritated by the tenor of his post-meltdown pitch.
The benefits of this sort of activity being conducted in a forum such as Silicon Investor, rather than through the traditional stock market networks and arenas of mining conventions, "dog and pony" shows, strip joints and cocktail lounges, is that there remains a permanent record of what's been said on-line. Promoters of junior stocks routinely find their words coming out of the mouths of brokerage house analysts, mutual fund managers and advisors and others who trade in speculative, small cap, issues (that, with their help, can balloon into mid-cap stocks or, even, TSE 300 contenders). The "street' has long operated this way. Through the medium of the internet, these traditional "inside" lines can be used to lure investors in a potentially much larger pool. As a counter-weight to this effect, the postings create an electronic audit trail for government securities investigators, police, or lawyers should they ever choose to become more expansive in casting their own nets.
The understanding of this new medium represents a steep learning curve for some. Even though the on-line discussions about Bre-X - in usenet newsgroups, on Silicon Investor and elsewhere -- remain archived for anyone to research today, the Bre-X internet experience has, so far, been mischaracterized in media coverage and books. While there exists evidence that public investors bought and sold shares based upon inaccurate and false reports published - in hard copy and electronic formats -- by the Bre-X group and/or North American brokerage firms, there has been no evidence presented to support the much-parroted urban myth that Bre-X shares rose and fell on hype and rumours that originated on the internet.
Ironically, the only specific instance that's been cited as grounds for claiming that internet discussions affected the stock price of Bre-X can be shown to be completely wrong-headed. Analysis of the chronological events in this instance reveal that on April 23 1997 a rumour that Freeport McMoRan's CEO Jim Bob Moffett had resigned, (supposedly falling on his sword over his firm's "mistake" in finding no gold at Busang), spread through the Canadian brokerage community. As is the nature of the (frequently reactive) medium, this rumour was picked up and questioned by posters on the internet. The on-line discussion of the false Moffett story did not get going until after the Bre-X stock price spike - from $3.00 to $5.75 - was substantially completed. On-line commentators quickly debunked the rumour and traced its source back to offices of one senior Bay Street firm. Somehow - either through simple ignorance or, possibly, efforts of Bre-X supporters and/or those in the brokerage community to establish a smokescreen - this circumstance has been repeatedly used by off-line commentators to illustrate the dangers posed by the net -- even though it demonstrates just the opposite.
Fortunately, not all situations are as twisted as those in the realm of Bre-X. It's unusual to find direct family members being fervent posters in support of a relative's public companies. Still, with the common use of pseudonyms on Silicon investor and in most on-line communities, it becomes essential to judge a posting by its content rather than by the name or title of its author. Which isn't a bad rule of thumb when it comes to junior stock watching - period. Only when a particular poster has shown a pattern to their content, is it possible to assign some credibility rating to the author. There is a certain equalizing force to this sort of empirical assessment.
In the case of the YBM Magnex, the company's drum was beaten capably by a more typical on-line poster, Richard Lam. Lam joined SI in July 1996 and created the first YBM discussion thread the following month. (By December 1996, he was so excited by the company's prospects that he launched a second, separate, discussion thread but there was not enough "traffic" to support more than one YBM chat group on SI.) Like many of those who appear as fans of stocks, Lam may fit within the investor category of inexperienced true believer.
The posts of Richard Lam and others informed on-line readers, or "lurkers", as to the company's ever-improving fortunes, and provided such details as the names of Canadian mutual fund managers who were highly touting YBM stock. Inexplicably, on January 25 1998 Richard Lam stopped posting to the YBM thread he'd created (and made his last post to any Silicon Investor thread on April 24 1998). His final words on YBM were characteristically enthusiastic: "At 15x historical earnings, superb profitability, and strong cashflows, still a great investment."
Regrettably, investor friends and confidantes found on-line can vanish almost overnight. Some return after a hiatus in the three-dimensional world, others are just plain gone. In the confusing days since FBI, IRS and other U.S. federal agents raided the Newtown, Pennsylvania headquarters of YBM Magnex as part of an extensive criminal probe, the SI discussion thread has experienced a decrease in the number of individual posters. Almost all of those who'd kept the thread buoyant for some 18 months prior to the May 13 1998 raid have sunk from view.
Of course, YBM Magnex has never appeared to enjoy a wide base of interest and support among the individual, or "retail", investor community. Being a former floor-trader, and having investigated stock trading patterns in numerous cases in the more than ten years since I left the trading floor of the Vancouver Stock Exchange (after reporting my employers to the authorities for their role in orchestrating a gross stock manipulation), one of the elements I look at when performing a due diligence review, in addition to corporate history, background of principals etc., is the trading history of shares in a public company.
The public disclosure record of YBM Magnex (e.g. regarding Arigon and its other founding interests), the dubious Howe Street background of two of its founding public directors, Michael Schmidt and Kenneth Davies, the promotional research reports issued by Bay Street brokerages. these were cause for circumspection or alarm. The company's extraordinary trading pattern, as evidenced by public record data (readily available through Stockwatch and other sources), can better be characterized as intriguing. Without gaining access to brokerage company records or "blotters" it is not possible to say much more than that.
One of the most immediately remarkable features that is apparent when looking at the trading pattern of YBM Magnex stock (that is, when it was still trading) is the fact that the buying and selling of shares in the company appears to be very narrowly distributed. A junior company whose stock has made the phenomenal climb from the level of a penny stock up to a peak over CDN $20 and a market capitalization (= stock price X number of outstanding shares) of more than CDN $900 million might be expected to have attracted quite a legion of fans en route.
Such does not appear to be the case with YBM Magnex. Even with more than 44 million shares issued and outstanding, YBM's stock trading is concentrated within a relatively small group of hands.
On many trading days about 80 to 90 percent of YBM's share volume on the Toronto Stock Exchange is accounted for by a handful of trades, often large "blocks", executed by a core group of the same Bay Street brokerage houses. Frequently these block trades are "crosses" - transactions in which the same brokerage house acts as, both, buyer and seller. This pattern may be evident regardless of the volume of shares traded -- whether it be on YBM's more typical days trading stock in a range of tens of thousands up to the less frequent sessions when hundreds of thousands of shares, or more, are shuffled. (Naturally, on those lighter trading days when the activity is dominated by one or a few houses the individual trades are not of the same magnitude as they are on bigger volume days.)
An example of a typical heavy-trading day for YBM Magnex on the TSE would be February 23 1998 when 374,920 shares traded at prices between $19.15 and $19.60 per share. On that date two crosses by First Marathon Securities - one of 250,000 shares and another block trade of 50,000 shares - added up to 300,000 shares or 80.0% of the day's total. There were a total of 73 separate transactions on the day, including the two First Marathon crosses.
The busiest day ever on the TSE for YBM stock was February 4 1998 when a total of 3,655,945 shares traded. From a distance, say, looking at this statistic in a newspaper summary or scanning a chart of the company's stock, this would appear to indicate a very active market in YBM stock and lots of investor interest. But, again, examination of the trading data suggests further that YBM lacks a widespread public base of individual, or "retail", investors.
On February 4, YBM's record high volume trading day on the TSE, First Marathon crossed two YBM blocks (1,204,500 shares + 762,900 shares) creating volume of 1,967,400 shares. Griffiths McBurney & Partners crossed two blocks (1,566,900 shares + 104,500 shares) in YBM totalling 1,671,400 shares. These four trades carried out by First Marathon and Griffiths accounted for 3,638,800 of the day's trading total of 3,655,945 shares traded - representing an amazing 99.53 percent of the YBM stock moved during the session. In total, there were 39 separate transactions on this date. Four trades accounted for 99.53 percent of the volume, the other 35 trades contributed 0.47 percent.
On May 13 1998, the day that five dozen agents for the FBI and other U.S. federal agencies swarmed the headquarters of YBM Magnex, the company's stock experienced uncharacteristically high share trading volume on the TSE. Still, this was not the result of market activity by large numbers of retail investors. Before YBM stock was halted - 23 minutes after the fed's raid began - a total of 1,134,011 shares were traded. Of this amount, four crosses by Griffiths McBurney acounted for 1,052,800 shares -- or 92.84 percent of the daily volume. There were a total of 110 separate transactions on the day.
Who has been behind these large trades executed by First Marathon, Griffiths McBurney and a few other houses? Mutual funds? Pension funds? YBM insiders? Hungarians? Russians? Israelis? What is the significance of these trades? The records needed to answer such questions can only be obtained by police, securities regulators, civil litigants or others empowered to access confidential brokerage records.
One thing is evident from review of YBM's stock trading pattern - the company, in terms of retail investors, is not nearly as public a venture as some other junior high flyers that have made news in recent times. For example, Bre-X Minerals, when it was trading on the TSE in a price range similar to that of YBM, would trade heavy volumes of shares made up of hundreds, or thousands, of small, individual, transactions. On YBM's most-active-ever day on the TSE, a total of 3,655,945 shares traded in just 39 separate transactions (and just four trades accounted for close to 100 percent of this volume). On a typical multimillion share day for Bre-X, February 24 1997, a total of 3,767,703 shares were traded in 2604 transactions.
A lack of retail public distribution likely accounts for the lack of widespread discussion of YBM Magnex on the internet. Until recently - and the FBI et al raid, auditor's concerns raised, the trading halt, public awareness of the company's Russian mafia roots -- outside of mutual fund managers, advisors, and brokerage analysts, there existed a comparatively small number of people who followed the stock intently. Prospective class action lawyers will find that, although they are out there, it will take more work to locate small investors in YBM than in such past Canadian stock promotions as Bre-X Minerals or Harvard International Technologies (the overheated french-fry vendor that flamed out in the mid-1990s with Canada's ex-Prime Minister John Turner wearing a director's apron).
It's a feature of the Canadian stock markets today, driven by managed money accounts (e.g. mutual and pension funds), that when a stock promotion falters or crashes, the institutional managers of accounts routinely fail to pursue possible financial remedies on behalf of their unitholders, pensioners etc.
In the decade since forestry company Doman Industries' shares clearcut a portion of the CBC news network's pension fund - and led to insider trading charges against British Columbia's former premier Bill Bennett and others - there has been curiously little legal response from burned pension and mutual funds in this country. Lawyers for the CBC extracted a settlement on behalf of that pension fund, but those money managers who play with other peoples' money by buying shares in small or mid-cap stocks, particularly those spawned on the speculative, high-risk, Alberta and Vancouver exchanges, are remarkably sanguine when losses result from their questionable picks.
Why do industry professionals backing stocks like YBM Magnex appear so content to write down such purchases and leave it at that? That's a question the public may well ask some day. Questions about the levels of due diligence carried out by mutual fund managers, advisors and securities analysts, naturally, dovetail with this line of inquiry.
My own YBM due diligence review had brought me to the SEDAR web-site where I located the report of auditors Deloitte & Touche LLP along with various related notes, schedules and management discussion documents that had been filed in late 1997. The one thing I didn't find was the basis on which First Marathon's analyst, Kaan Oran, could claim that YBM Magnex had passed this audit "with flying colours."
Certain findings of the audit were disturbing and when viewed in an overall due diligence context -- informed by knowledge of other questionable elements of the company's history, principals, and public disclosure practices - they heightened a growing sense of alarm about YBM Magnex.
That any professional would put such a positive spin on this situation seemed more than bizarre - it appeared downright negligent or reckless.
I was a long-time follower of the trade journal and news service Canada Stockwatch, a regular user of its helpful data library, and an occasional contributor of research and writing. I spoke with John Woods, the editor and publisher of Stockwatch, about a need to inform public investors who might be following the words of securities analysts and the like and, consequently, not be fully aware of YBM's unusual corporate affairs.
Woods, who had been a veteran floor trader before starting up Stockwatch as a research vehicle, has no difficulty spotting a skewed trading pattern or smelling a questionable stock deal.
Over the previous decade, Stockwatch had been alert to bring to public attention many securities industry troubles and trouble-makers. Technigen Corp., the golf machine scam which had given YBM director Mike Schmidt some practical investor relations experience, had first been exposed by the publication (in a market summary I'd written for Woods). Stockwatch helped drive VSE promoter Harry Moll (infamous for the Pineridge affair scandal that cost European investors many million$) to tax exile status in the Cayman Islands. It had revealed the links of more than 50 inflated VSE promotions to accounts of a pension fund in the West Midlands of England, the Wolverhampton Borough Council Superannuation Fund. John Woods was first to highlight the dubious dealings of promoters Ed "The Shadow" Carter and David Ward (since slain execution style and found in his car). In the mid-1980s Carter and Ward had bribed a Texas mutual fund manager over $1 million to bury more than $20 million under his management into more than a dozen virtually worthless VSE stocks. Stockwatch had written about questionable trading by Altamira funds under "guru" Frank Mersch in the shares of a small cap stock promoted by mining deal hustler Robert Friedland as early as 1993. Stockwatch writer Brent Mudry investigated the dealings of AGF/Fidelity fund "diva" Veronika Hirsch and broke the news of her personal trading violations in 1996. These and numerous other stories chronicling Canada's ever-broadening market in junior stocks and the embracing culture of the securities industry were to its credit.
John Woods assessed this new situation and published my first report on YBM Magnex on March 10 1998, the same day that YBM shares hit their all-time high mark of $20.15. Following is the feature as it originally ran in Stockwatch:
Unusual corporate affairs leave analysts and investors happy...
The balance of Part 4 of the YBM Magnex series is available on my web-site @ imagen.net
The whole article is too large to post here on SI. |
