For four years, YBM Magnex International Inc. was a darling on the Canadian stock markets. The small Pennsylvania-based magnet maker grew from a shell company that traded for pennies on the wild and woolly Alberta Stock Exchange to a global industrial player whose stock climbed to nearly $14 a share last March, hiking its market value above $600 million. It was boosted by analysts from some of Canada's toniest brokerage houses. As a way to tap into promising trade with the former Eastern bloc, it stirred interest and recruited high-profile board members.
The bubble burst on May 13, when the U.S. Customs Service, Federal Bureau of Investigation, Internal Revenue Service, and Immigration & Naturalization Service raided the company's Philadelphia-area headquarters. A spokeswoman for the Royal Canadian Mounted Police says the raid was part of a two-year criminal investigation. Trading in YBM has been suspended on the Toronto Stock Exchange. The company, whose auditors, Deloitte & Touche, say it may have been involved in "illegal acts," is awaiting a report by outside investigators requested by the independent directors. YBM spokesman Guy Scala says the company is "aware of no facts which support speculation that it has engaged in unlawful acts."
What's most remarkable about the YBM saga is the veritable forest of red flags that were ignored by Canadian securities regulators, brokerage executives, and investors: disturbing associations with alleged Russian gangsters, suspicions of money laundering that drew the eyes of law enforcers worldwide, and the company's questionable financial statements. Regulators, who knew of YBM's dubious origins, cleared it for trading first in Alberta and then on the prestigious Toronto exchange. And investors, especially many of Canada's major-league mutual funds, helped YBM through a $34 million public offering last fall. "As a Canadian investor, I find it embarrassing," says Stephen Foerster, an associate professor of finance at the University of Western Ontario. "It can tarnish the image of Canadian markets in general."
Hints of trouble have surrounded YBM since 1994. First, there was its peculiar start: YBM's backers--chiefly Jacob G. Bogatin, a Russian-born magnet-science expert, and Semeon Mogilevitch, a suspected organized-crime leader from Hungary who together with relatives and associates was a principal YBM shareholder--picked up a worthless corporate shell on the Alberta Stock Exchange called Pratecs Technologies Inc. By going public through merging YBM into Pratecs, they avoided the intense scrutiny that accompanies an initial public offering--either in the U.S. or in Canada. Bogatin declined to comment. Attempts to reach Mogilevitch to obtain his response to this article were unsuccessful. Scala says Mogilevitch had no role in management and now is only a small shareholder.
The most glaring sign of problems arose in mid-1995. Pratecs halted trading for six weeks when Alberta exchange officials were alerted that British investigators were looking into an affiliated outfit, Arigon Co., on suspicions of money laundering. For a time, Arigon's assets were frozen in Britain, but legal actions were dropped. Mogilevitch, however, was banned from entering Britain. Nonetheless, officials of the Alberta Stock Exchange permitted trading to resume, explaining that they couldn't bar it without proved wrongdoing.
Despite its questionable origins, Pratecs changed its name to YBM and was able to rebuild its reputation with the help of some of Canada's most distinguished brokerage firms. In late 1995, First Marathon Securities Ltd., Canada's largest independent investment house, and Griffiths McBurney & Partners, seemingly entranced by the company's promising ventures in the fast-growing former communist countries, helped YBM through a $9.4 million underwriting. A spokesman for First Marathon says due-diligence reviews on YBM were "comprehensive" and took note of the British investigations but cleared the firm for investment anyway. Says First Marathon's spokesman F. Michael Walsh, "We were as much taken by surprise by these events as anyone."
BARTER BIZ? Critics say the underwriters would not have had to look far for trouble signs regarding Mogilevitch and his associates. Magnex and its subsidiary, Arigon, turned up in overseas news accounts about Russian mobsters in 1995. More recently, warning signs arose within YBM: Deloitte & Touche raised worries about how the company does business. Primarily a maker and seller of industrial magnets, it also apparently traded diesel oil through complex bartering arrangements in Eastern Europe that confounded Western auditors. In its prospectus, the company noted that D&T reported the oil wasn't accurately recorded in inventory because of "inadvertent error on the part of management." A YBM spokesman says it does not take part directly in bartering.
Analysts, though, kept supporting the stock. When it dipped in March, Nesbitt Burns analyst Peter Sklar gushed that the "fundamental prospects for the company are intact and that the recent weakness presents a buying opportunity." Vancouver market critic Adrian du Plessis, who has written extensively on YBM, complains analysts "don't do their homework." Sklar declined comment.
To some critics, the YBM saga dramatizes the shortcomings of the fragmented regulation in Canadian securities markets. "Maybe we need to upgrade the whole practice in Canada and harmonize it with similar practices in the U.S.," says G. Andrew Karolyi, a professor of finance at the University of Western Ontario. Coming on the heels of last year's multibillion-dollar Bre-X Minerals Ltd. gold-mining scandal, Canada's stock markets can't afford yet another humiliating black eye.