the inevitable happens
YBM Magnex International Inc -
Application to appoint receiver and manager
YBM Magnex International Inc YBM
Shares issued 44,222,901 1998-05-13 close $14.35
Tuesday Dec 8 1998
Mr. G. Wesley Voorheis reports
YBM Magnex applied to the Alberta Court of Queen's Bench for the appointment by the court of Ernst & Young YBM Inc. (E&Y) as receiver and manager of the assets, property and undertaking of YBM.
A summary of the background and reasons for the board of directors' decision to make this application is set out below.
Background
On March 23, 1998, during the course of performing its audit of YBM's 1997 financial statements, Deloitte & Touche LLP raised concerns at a meeting of YBM's audit committee about certain transactions conducted by one or more of YBM's Eastern European subsidiaries during 1997.
On April 20, 1998, Deloitte advised YBM that "our preliminary search has also indicated that certain individuals associated with these entities and certain other related entities are reputed to have ties with organized crime. The information obtained heightens our serious concerns that these transactions may be bogus and are being used to cover the flow of money between these companies for other purposes."
On May 13, 1998, the head office of YBM in Newtown, Pennsylvania was the subject of a search and seizure warrant by representatives of the United States Attorney's Office, the Federal Bureau of Investigation, the Internal Revenue Service, the Immigration and Naturalization Service, the U.S. Customs Office and others under the umbrella of the Organized Crime Strike Force (the U.S. authorities). Also on May 13, 1998 the Ontario Securities Commission issued a temporary cease trading order in respect of the securities of YBM. On May 14, 1998 the Alberta Securities Commission issued a similar order.
Formal investigations or proceedings relating to YBM are continuing in the United States by the Organized Crime Strike Force and in Canada by the ASC and the OSC. These investigations and proceedings, as well as the public announcements of YBM and the press coverage they have received commencing in May 1998, created a significant state of uncertainty and resulted in a material deterioration in the business and financial condition of YBM.
On Sept. 22, 1998, a substantial group of YBM's shareholders supported an application to the Alberta court which resulted in an order replacing the majority of the then existing board of directors. Since that time, the new board of directors has attempted to review the principal issues affecting YBM, to co-operate with the regulatory authorities and to preserve and protect as much as possible the value of the assets of YBM for the benefit of its shareholders.
new board of directors of YBM has been advised or has concluded as follows:
YBM's U.S. criminal counsel has advised that YBM is certain to be indicted by a grand jury in the United States, absent prior agreement by it to enter into a guilty plea agreement, and there is good reason to believe that the U.S. authorities will be able to marshall substantial credible evidence of criminal wrongdoing in connection with YBM;
YBM may well not be able to defend a criminal indictment initiated by the U.S. authorities;
the issues facing YBM have resulted in the resignation of YBM's president and chief executive officer and have created a set of circumstances such that it will be virtually impossible to find a suitable replacement for him;
in light of the current circumstances facing YBM and the serious issues which have been raised regarding YBM's prior business activities, the board of directors does not consider that it has the ability to adequately or responsibly supervise YBM's continuing business and affairs to ensure that such business and affairs are lawfully and appropriately conducted;
based on the results of a forensic investigation conducted by Miller Tate & Co., a Philadelphia-based forensic accounting firm retained by counsel for YBM, there is no realistic possibility of YBM obtaining audited financial statements for 1997 nor is there a realistic possibility of YBM ever retaining a competent auditor, and therefore there is no real likelihood of the shares of YBM ever resuming trading or for YBM to have access to financing on commercial terms, whether from a financial institution, through access to the capital markets or otherwise;
in light of serious unresolved issues regarding YBM's Eastern European business operations, which in the past have generated a majority of YBM's reported profits and revenues, there is a substantial risk that such operations or a substantial portion of them may not be sustainable in the future. The overall continuing operations of YBM on any reasonable set of assumptions will likely continue to generate negative cash flow;
if the major elements of the status quo continue, the cash and other assets of YBM likely will be exhausted or diminished in value with the result that there will be no prospect of any return for YBM's shareholders through a distribution; and
a court supervised process is the optimal method available to preserve and realize on the assets of YBM and its subsidiaries for the benefit of all its stakeholders.
Investigations by the New Board of Directors
On Sept. 23, 1998, the new board of directors formed a special committee. The mandate of the special committee was to independently identify and assess the principal issues which affect the business and affairs of YBM and to consider all alternatives available to preserve and enhance shareholder value for the benefit of all shareholders.
Pursuant to this mandate, members of the special committee or their representatives conducted numerous interviews with:
present and former legal advisors and consultants to YBM;
present and former members of senior management of YBM and its subsidiaries;
representatives of the Organized Crime Strike Force;
representatives of the OSC and the Toronto Stock Exchange; and
representatives of YBM's principal North American banks.
A meeting with Deloitte, which resigned on June 24, 1998 as the auditor of YBM, was requested but refused.
The members of the special committee and its advisers also reviewed reports to YBM prepared and provided by management of YBM and its subsidiaries and other documents considered appropriate including various reports prepared by the committee of the board of directors formed in March 1998 to review certain transactions conducted by one or more of YBM's Eastern European subsidiaries during 1997.
Financial Management and Control Issues
The new directors believed that, as a first priority, it was critical to implement strict controls over YBM's activities and to safeguard its cash resources. The steps taken by the board of directors included:
that approximately $18.1-million (U.S.) held by United Trade Limited (a Cayman Islands subsidiary of YBM) be returned immediately to a bank account in Canada of YBM by way of repayment of inter-company loans;
directing that the signing authorities in respect of specified bank accounts maintained by YBM and its subsidiaries be amended so that transactions in excess of $75,000 (U.S.) require the written authorization of one of the new directors;
requiring that all cheques, wire transfers or contracts of YBM or its subsidiaries in excess of $75,000 (U.S.) be subject to prior board approval; and
directing that there be no further transactions between YBM or its subsidiaries and certain specified entities that had been identified as being involved in suspect transactions with United Trade unless and until the board was satisfied as to the legitimacy of the entities concerned and of the proposed transactions themselves.
To date, notwithstanding repeated efforts by the board of directors of YBM to exert control over the operations of YBM and its subsidiaries, particularly in Eastern Europe, there have been continuing difficulties in securing compliance with these controls.
Financial Condition
In October 1998, the board was advised by management that, among other things:
the business of YBM's Eastern European subsidiaries had deteriorated badly and that, although some orders continued to be received, payments in respect of new orders and aging accounts receivable were extremely slow;
YBM's business in Eastern Europe would continue to suffer badly pending resolution of the ongoing regulatory investigation in the U.S.;
the continuing U.S. regulatory investigation is the critical problem facing YBM and its subsidiaries and, in management's view, representatives of the board of directors should meet with the U.S. Attorney's Office, offer full co-operation, and attempt to resolve all issues;
each of YBM's subsidiaries in Eastern Europe and the U.K. were cash flow negative;
if the status quo continues, YBM will have exhausted its cash resources within one year;
without a quick resolution of the U.S. regulatory investigation, many key employees would soon resign, which would permanently and irreparably damage the future prospects of YBM; and
the board of directors must either immediately implement a credible plan for resolving the U.S. regulatory investigation or effect a fundamental restructuring of the operations of YBM, otherwise the business of YBM and its subsidiaries would be destroyed forever.
Also in October 1998, YBM's management provided the board with an operations overview report for September 1998 which included an overview of YBM's purported September 1998 financial performance stating that:
YBM had net sales of $8.2-million (U.S.) (budget $16-million (U.S.)) and a net loss of $13.9-million (U.S.) (budget net income of $2.8-million (U.S.)) during September 1998;
the amount of YBM's net loss during September 1998 was largely attributable to a $14.3-million (U.S.) charge taken during September 1998 in respect of uncollectible accounts receivable owing to United Trade;
YBM had net sales of $99.2-million (U.S.) (budget $135.5-million (U.S.)) and a net loss of $6.3-million (U.S.) (budget net income of $26.5-million (U.S.)) for the nine months ended Sept. 30, 1998;
as at Sept. 30, 1998, YBM and its subsidiaries had cash and liquid assets of $27.7-million (U.S.);
immediately prior to recording the $14.3-million (U.S.) charge in respect of its outstanding account receivables, United Trade had outstanding accounts receivable from Eastern European entities of approximately $25-million. YBM management stated that, unless there was a material change in the Eastern European economic environment in the near future, no more than 10 per cent to 20 per cent of these accounts receivable may be collected.
More recently, YBM's management provided a draft operations overview report for October 1998 which included an overview of YBM's purported October 1998 financial performance stating that:
YBM had net sales of $7.2-million (U.S.) (budget $16.7-million (U.S.)) and a loss of $1.2-million (U.S.) (budget net income of $2.9-million (U.S.)) during October 1998;
YBM had a net decrease in cash and cash equivalents of $2.6-million (U.S.) during October 1998 and $34.1-million (U.S.) for the 10 months ended Oct. 31, 1998; and
as at Oct. 31, 1998, YBM and its subsidiaries had cash and liquid investments of $25.1-million (U.S.).
The board of directors has not independently verified any management financial reports which it received.
On Dec. 2, 1998, members of the special committee were advised by management that United Trade's sales had decreased to nil and that YBM's Eastern European management had decided, in light of the fact that neither United Trade nor Magnex RT (a Hungarian subsidiary of YBM) was presently generating any meaningful levels of sales, to shut down substantially all of Magnex RT's manufacturing operations at least until February 1999. This decision was made without the knowledge or prior approval of YBM's board of directors.
As at Nov. 27, 1998, YBM management advised that YBM and its subsidiaries had a total of approximately $23.6-million (U.S.) in their bank accounts, substantially all of which was in YBM's bank accounts in Canada.
As contemplated in the YBM press release dated Sept. 24, 1998, the directors reviewed the reduction in cash on hand from May 31, 1998 to Aug. 31, 1998 of approximately $20-million (U.S.). The directors commissioned a report which shows that these funds were spent on the repayment of loans, payments to suppliers, capital expenditures, salaries and general administrative expenses, the majority of which were made in North America.
United States Regulatory and Criminal Investigation
YBM's management has stated to the board of directors that public knowledge of the existence of the U.S. investigation has negatively impacted, among other things, YBM's financial results, its credibility and relationship with its customers and suppliers, its credibility and relationship with Eastern European governmental authorities, its banking relationships, its ability to raise financing, its ability to obtain an audit opinion in respect of its 1997 financial statements and its management and employees.
Since Sept. 22, 1998, members of the special committee and its representatives have met on several occasions with representatives of the Organized Crime Strike Force who are investigating YBM. While the new directors do not know the precise scope of the Organized Crime Strike Force's criminal investigation of YBM, they believe that at least some of the factual allegations likely to form the basis of an indictment are reflected in the concerns expressed by Deloitte and the OSC and that the U.S. investigation may involve or relate to the possible links between YBM and certain alleged organized crime members.
Based upon investigations conducted by members of the special committee, including legal and other advice received by it, the new directors believe that there is a substantial risk that YBM would face a number of significant hurdles in presenting a defence to the extent that it is indicted by the grand jury. The directors have been advised by YBM's U.S. criminal counsel that, should YBM be convicted of criminal wrongdoing, the financial consequences are likely to be severe and, in the absence of agreement on the terms of a guilty plea, could include a fine and restitution order sufficient to deprive YBM of substantially all of its assets.
While members of the special committee have had discussions with representatives of the Organized Crime Strike Force regarding a basis upon which YBM might resolve the matters of concern to the Organized Crime Strike Force, no agreement has been reached. The directors believe it would be in the best interests of YBM's shareholders for E&Y, if it is appointed as receiver and manager of YBM, to have the power to continue to explore discussions with the U.S. Attorney's Office regarding a possible settlement of the matters of concern to the Organized Crime Strike Force. The directors believe that a major concern of both the Organized Crime Strike Force and the OSC is to ensure that the innocent shareholders receive as much of the remaining value of YBM's businesses as possible.
Inability to Resolve Concerns Raised by Deloitte and the OSC
Following the reconstitution of the board, the members of the special committee asked Miller Tate to continue its detailed forensic investigation of certain business activities conducted by United Trade during 1996 and 1997 in order to permit the board to understand and address the issues raised by Deloitte and the OSC.
On Dec. 4, 1998, Miller Tate delivered an interim written report to YBM's board of directors outlining the information reviewed and analyzed as of that date by Miller Tate, its findings and certain other information which had come to Miller Tate's attention.
The executive summary to Miller Tate's interim report dated Dec. 4, 1998 states, in relevant part, that:
1. "The issues raised by the OSC and Deloitte & Touche are real and require a full explanation by YBM. Despite Miller Tate's repeated requests for information and relevant supporting documentation, we have to date been unable to assemble the necessary evidence which in our view is required to provide a satisfactory explanation of the transactions which were challenged by both the OSC and Deloitte & Touche. In fact, Miller Tate's review of documentation provided to it has raised additional concerns regarding the bona fides or legitimacy of transactions entered into by United Trade and various parties to these transactions.
2. We have been unable to obtain what we would consider normal, generic supporting documentation for the transactions effected by United Trade with which the OSC and Deloitte & Touche raised concerns. The type of documentation requested by Miller Tate is of a nature which, in our opinion, should in the ordinary course be maintained in the records of any properly managed public (or private) company. In most instances, significant transactions involving substantial sums of money are not supported by corroborative evidence. ... To date, we have been unable to assemble "competent auditable evidence" -- (and, in some instances, no evidence at all) -- with regard to the questioned transactions. The concerns raised by Deloitte & Touche regarding the nature of certain transactions and the relationships among parties to these transactions have not been resolved.
3. ... While YBM's management continues to insist that adequate supporting documentation exists in Hungary, such documentation has not been provided to Miller Tate. The failure of YBM's management to fully and completely co-operate with our engagement by providing any and all documentation and assistance is extremely troubling.
4. ... Despite repeated requests, YBM has not supplied supporting bank document information for 1997. The failure of United Trade to maintain underlying wire transfer information for 1997 related to substantially all of its 1997 business transactions precludes our investigation of those transactions and precludes us from determining the bona fides of such transactions ...
5. During the course of the engagement, Miller Tate became aware of several transactions effected by United Trade involving the movement of substantial amounts of money though bank accounts controlled by United Trade. These transactions, which have several indicia of money laundering, were never adequately explained by YBM's management.
6. The apparent inter-relationships, including shared addresses, among parties which conducted business with United Trade during 1996 and 1997, and the unexplained nature of many of the transactions pursuant to which significant amounts of money flowed between these apparently related parties through United Trade's bank accounts, raises the spectre, absent a properly documented explanation, that certain transactions conducted by United Trade may not have been bona fide. To date, no such adequate explanation has been received by Miller Tate.
7. Miller Tate could not substantiate YBM's geographic segmentation data in respect of its sales revenues presented in either of its two sets of audited financial statements for 1996. Indeed, Miller Tate uncovered a "third" version which had been created by YBM's management and showed sales to non-existent United States customers.
8. During 1996 and 1997, United Trade effected substantial purchases and resales of samarium and neodymium magnets. These transactions ... played a greater and greater role in YBM's revenues and profits in 1996 and 1997. ... Miller Tate was never supplied with adequate third party documentation to demonstrate the legitimacy of these purchases and resale transactions.
9. United Trade also effected substantial purchases and sales of diesel oil during 1996 and 1997. ... Despite repeated requests, Miller Tate was never provided with adequate evidence of the existence of the diesel oil or the legitimacy of these transactions. ...
10. Miller Tate has been unable to satisfactorily resolve the issues raised by Deloitte & Touche and the OSC relating to technology contracts, equipment upgrades, repair and maintenance contracts, plant acquisition agreements and other capital contracts entered into by United Trade during 1997. Notwithstanding the significance of these transactions, Miller Tate was not provided with adequate supporting documentation to establish their legitimacy. Further concerns have been raised by the nature and extent of the apparent inter-relationships among the parties to these transactions."
The directors are concerned about the accuracy of YBM's prior financial results, including for the years ended Dec. 31, 1996 and 1997.
Conclusion
On the basis of the foregoing the board believes that shareholders of YBM have no reasonable prospect of being able to sell their YBM shares and no means of liquidating their investment in YBM, other than through a distribution made to them by YBM in respect of their shares.
In all the circumstances, the directors believe that an international accounting firm of the stature of E&Y, which has offices throughout the world, would be better able to preserve and realize on the assets of YBM than its current board of directors. Therefore, the directors have tendered their resignations as directors of YBM, conditional upon E&Y's appointment as receiver and manager of YBM.
YBM Magnex International Inc YBM
Shares issued 44,222,901 1998-05-13 close $14.35
Wednesday Dec 9 1998
Mr. Eusis Dougan-McKenzie reports
Ernst & Young YBM Inc. has been appointed by the Alberta Court of Queen's Bench as the receiver and manager of the assets, property and undertaking of YBM Magnex International, Inc. (YBMI). YBMI is a public holding company that is the direct and ultimate shareholder of operating subsidiaries in the United States, United Kingdom and Hungary. The receiver confirmed that, pending completion of its preliminary assessment, the subsidiaries continue under existing management, reporting to the receiver.
(c) Copyright 1998 Canjex Publishing Ltd. canada-stockwatch.com
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