Wednesday 23 August 2017

Numbers game as analysts turned SEC whistle-blowers win $2.5m

Stock-market-listed Orthofix International caught one of the analysts' attention in 2012. Stock image
Stock-market-listed Orthofix International caught one of the analysts' attention in 2012. Stock image

Sarah N Lynch

Four years ago, two analysts who liked to swap notes on numbers they thought looked odd took a fateful step and tipped off US regulators about a company that one of them had watched for months.

Stock-market-listed Orthofix International caught one of the analysts' attention in 2012.

The Texas-based medical device maker kept hitting ambitious earnings targets and many analysts had "buy" recommendations for the stock. But the analyst thought something was off.

Earnings reports showed it was taking longer than usual for the company to get paid by wholesale customers, invoices were piling up and executives struggled to offer a convincing explanation, blaming logistical problems at foreign offices.

The analyst spent months tracking quarterly reports and earning calls, and using algorithms to compare Orthofix's ratios and patterns of sales and inventory turnover with financial data of its peers stored in databases such as Compustat.

"I am always on the lookout for something unusual, either just unusually good and underappreciated, or unusually bad," the analyst told Reuters.

"This one showed up as a company that looked like it had the potential to be unusually bad."

In the spring of 2013, he emailed his spreadsheets to a fellow analyst and a friend of more than a decade, with whom he regularly chatted about companies and sectors.

"The way we work together is one person makes a suggestion and the other person challenges it," that friend told Reuters.

"It is like a war game."

In Orthofix's case, what the two analysts pieced together suggested that Orthofix was goosing its earnings by 'channel stuffing'.

If not disclosed to investors, the practice of flooding distributors with more products than they can use or pay for is illegal.

It lets the company smooth earnings by prematurely recognizing revenue, and pushing shortfalls into the future.

Now both men stand to win as much as $2.5m (€2.28m) after Orthofix reached an $8.25m (€7.5m) settlement in January with the Securities and Exchange Commission (SEC).

Several former executives also collectively paid $120,000 (€109,600) in penalties to resolve accounting fraud charges.

The award might even be bigger, if the SEC also credits the analysts' tip for leading to a second civil settlement concerning foreign corrupt practices charges.

The pair have declined to be publicly identified, citing concerns that to do so might jeopardise their current professional relations.

Referring to its January settlement with the SEC, Orthofix spokeswoman Denise Landry said the company had self-reported to the regulator and fully co-operated with the government during the investigation.

"We are pleased these matters are behind us," she said, declining to comment further.

By entering the SEC whistle-blower program the duo showed how outsiders with analytical skills and tools and time to spare can accomplish what is typically done by those with inside access to confidential information.

The Whistle-blower programme was launched to encourage insiders to report potential fraud.

However, since its inception a third of the more than $111m awarded to whistle-blowers has been to outsiders such as analysts or short-sellers, according to the SEC. (Reuters)

Irish Independent

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