8. The Competitive Edge

Investigative research can be a powerful tool that serves a variety of needs. In addition to providing information before a deal is done or resolving an issue after a problem has surfaced, investigative research is also a form of competitive intelligence. While the objective is slightly different, the same resources and creative approaches are applied when seeking to learn more about a competitor or company in which you have an interest.

On many occasions, we have worked with activist hedge funds and investors who hear industry rumors about a company and need to know the legitimacy of the rumor. Activist hedge funds are known for buying a large stake in a publicly traded company, thus giving the activist fund a voice with the management and operations of the firm. Therefore, any major changes within the public company would impact the activist fund’s returns, and so the activist fund needs to stay on top of the company’s activities. Is bankruptcy imminent? Will the CEO be ousted? Is the company under investigation by a regulatory authority? Essentially, activists need to know what is going on at the firm that may affect the sustainability of the company or the wallets of the shareholders.

The Situation: The Backdating Bluff

An activist fund heard rumors that one of its investments, Handoutz Corp., was involved in the backdating of company options. Backdating options is a practice where a public company allows a stockholder to buy options in the company at an earlier date, presumably a time when the stock was at a lower price, thus allowing the shares to increase in value. (grant date of options is backdated so exercise price is lower). If an executive has options dated April 3, 2004, when a company is trading at 45, backdating options allows the executive to purchase these options when the company is trading at 23, say in January 2004. The executive has just increased the value of his shares because he will have earned money from the 22-point rise in the company’s stock price. The practice itself is not necessarily illegal; it is the lack of disclosure in reporting the practice that violates SEC rules.

The activist fund Handoutz Corp. needed to know whether the rumors on the Yahoo! Finance message boards were true: Backdating of options had taken place, the officers had profited, and the shareholders were not apprised of the officers’ actions. To properly address the legitimacy of the rumors, we decided we had two initial questions to ask: Did the people making the allegations have any reason to spread false rumors, and had the officers of Handoutz ever been accused of anything similar in the past?

Through analyzing the postings on the message boards, we were able to determine that the rumor had originated months prior from one person, Jane Grudge, who was a former executive of Handoutz. While this was an interesting discovery, we still had not answered our initial questions and knew nothing about whether the backdating of options did actually take place. Because we knew none of the officers allegedly involved in the backdating would confess if confronted, we decided to take a circuitous route to get to the bottom of the situation: We began to look at Handoutz and the history of the company and the management team. We thought maybe we would find some information in either the backgrounds of the officers or the operations of the company that would give us a clue.

At first, we focused on the three main C-suite executives (CEO, CFO, and COO). In our review of federal-level civil cases, we found Handoutz and the C-suite execs were sued for sexual discrimination about six months before the rumors had hit the wires. The plaintiff was a woman named Jane Remisse, who lived in northern California and was a former high-level officer of Handoutz. With the approval of our client, we went to California to talk to Ms. Remisse. We knocked on the door and explained that we knew she had sued for sexual harassment but said we were more interested to know if she, as a former high-level employee, had any knowledge about the alleged backdating of options. Ms. Remisse said, “Well, why do you think I sued?” Confused, we asked what she meant, and Ms. Remisse elaborated: “I sued for sexual harassment because all of the boys had their options backdated and I didn’t.”

And as it turned out, the woman who was spreading the rumors on the message boards, Jane Grudge, was actually the same woman as Jane Remisse (her maiden name was Grudge). With this information, our activist fund client knew that there was indeed some legitimacy to the rumors and adjusted their position in the company accordingly.

The Situation: The Medicaid Fraud Mix

The competitive intelligence we gather does not always reap results of doom-and-gloom. We worked for another activist fund that had a stake in Medikal Mysleed, a public company that was in the healthcare industry. The activist fund manager saw a press release by the Medicaid Fraud Control Unit of the Attorney General’s office in a specific state that said Medikal Mysleed was under investigation for Medicaid fraud and stated that the CEO of the company was also named in this investigation. The press release also referenced other states that were investigating Medikal Mysleed for the same reasons. The activist fund manager hired us through counsel to determine exactly what the charges were; where else the company was being investigated; and, essentially, was the alleged Medicaid fraud a systemic problem that bled throughout the company, or was it the cause of just one officer, the CEO?

We began our inquiry by contacting Medicaid Fraud Control Units throughout the country. In some states, we had to submit a request under the Freedom of Information Act (FOIA). FOIA allows anyone to request information from a state or federal government agency. Of course, there are certain rules and situations by which the government agencies can deny your request, but sometimes FOIA requests do elicit relevant information. Between the FOIA requests sent to these state agencies and contacts we have who are former investigators at various fraud units across the country, we started to receive a lot of publicly available information.

By sifting through piles of official documents and stacks of Medicaid rules and regulations, we were able to find a common thread: The allegations made against the company, the reason for these investigations, could not have been based on activities undertaken by Medikal Mysleed. Through all of the documents we examined, Medikal Mysleed had abided by the laws. We were perplexed. We went back to our network of former fraud investigators and asked them to reach out to any sources they had at any of the agencies that were investigating Medikal Mysleed. We needed someone to explain what was going on.

We ultimately got in touch with someone who was willing to take the time to explain the way the process worked and why the company was being targeted given that it appeared the company was playing by the rules. Our source said he was familiar with the situation involving Medikal Mysleed and explained that the states had really been investigating the CEO for years and had been unable, thus far, to bring charges against him, so as is common practice, the attorneys general started to look at the company so they would have access to internal corporate documents that would assist them in their broader investigation of the CEO.

So the problems at Medikal Mysleed were in fact not prevalent within the company. With this intelligence, our activist fund client decided to rally other investors and board members and urged them to have the CEO ousted in order to save Medikal Mysleed. And that is exactly what happened. Medikal Mysleed is still thriving.

The Tactic: Going Old School

It seems pretty simple, if not possibly outdated, but picking up the phone and doing some tedious legwork of making telephone calls can often lead to some pertinent information. Such was the case with Medikal Mysleed. We spent hours contacting various fraud units throughout the country, and it was the information learned in these calls that led us to our conclusion with Medikal Mysleed. A telephone is obviously something to which every investor has access. Younger researchers tend to think everything is available on the Internet, but picking up the phone and making a live connection with another person can be invaluable.

Also with Medikal Mysleed, we were able to get more information by submitting a FOIA request. The Freedom of Information Act says, in essence, that any person can request access to information from any branch or department of the U.S. government. Of course, the government is not required to respond to all of the requests, but generally, unless the information is sealed, involves national security, or relates to an ongoing investigation, you will usually get some sort of response from the agency to which you submit a FOIA request. Because you never know what you will get, submitting a FOIA request is an easy tool that can sometimes reap relevant information.

In other instances, business intelligence helps companies understand what the competitive marketplace looks like and why, perhaps, sales are decreasing. Many companies go through natural ups and downs; sometimes this is dictated by the economy, and other times it is a result of a change in consumer needs. Other times, however, a new competitor may cause a drop in sales. While new competition is the backbone of our society, it is not always welcome when the newest competitor in your marketplace is also someone on your payroll.

The Situation: The Grapple in the Garment Industry

Disdress, a garment company in midtown-Manhattan, called us with concern. Their customers, they said, were inexplicably vanishing. Disdress wanted us to find out if there were new companies operating in the same market and what these companies were offering that caused their clients to switch.

While we were trying to identify any new companies in the garment district, we also asked to see a list of the current sales people at Disdress. We did a little research on these individuals to see if maybe someone was living beyond their means and thus might have another income stream and that could just possibly be their competition. Well, if we were not right with our hunches, then the story would not be in this book. But the fact that we were right is not as important as how we figured it out.

Patrick Guile, an employee of Disdress, lived in Weehawken, New Jersey. Weehawken residents have an easy commute to New York City, and Patrick Guile rented his apartment there. Living on a mild salary as a salesman of a small garment company, this living situation made sense. What did not make sense, however, was the forest green Jaguar XJ8 he had parked in his lot that sat next to the black BMW 7-series. And, no, Guile did not recently inherit any great sums of money from a dead aunt or any other relative (we checked). Guile was also not funded by a high-profile wife who earned money in her own job, and he did not have parents who supported his expensive habits (we checked). What Guile did have was a company formed in Delaware that mimicked Disdress’s product.

With the approval of Disdress and its outside counsel, we accessed Guile’s deleted emails from his Disdress email address and found an email to a Disdress customer saying, “Please send the commission to my home. I don’t want work to find out I’m doing this.” (We were able to do this because Disdress had an appropriate computer policy in place that allowed us to review these records.)

We then got the names of some of the Disdress accounts that had since ceased to do business with Disdress. We talked to these clients and asked them what was going on. While a few customers were not willing to talk to us, we were able to find a few former Disdress customers who said Guile told them he was leaving Disdress, which was why the customers agreed to do business with Guile. The customers said they were worried about the state of Disdress and figured if Guile was leaving and promising to give the customers the same product as they received through Disdress, then there would not be a problem. In essence, Guile was stealing from Disdress and lying to customers about it. Rather than try to prosecute Guile, which might have brought unwanted publicity to Disdress and the situation, Disdress decided to cut a deal with him.

The Tactic: Combing Through Corporate Documents

The key to discovering Patrick Guile’s antics rested in our ability to search corporate records. Anytime a company in any state is formed, the respective state keeps the corporate information on file. Some states, such as Delaware, do not require companies to include the names of officers or directors. But the details of the company name and the date the company was formed are always included in every state’s corporate record database. LexisNexis has compiled a very comprehensive database of corporate records throughout the country. Other than New Jersey and Delaware, which must be searched separately, LexisNexis is the go-to spot for searching corporate records.