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[DewDiligence]

Here’s the Barron’s cover story on
Business Intelligence Advisors:

http://online.barrons.com/article/SB115110329288989450.html

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Is Your CEO Lying?

By JONATHAN R. LAING
June 26, 2006

In their eternal quest to get an investment edge, hedge funds have long hired forensic accounting firms and even private detective agencies to ferret out dirt on short-sale targets. But now that pursuit has moved to another level.

Barron's recently stumbled across several hedge funds that have hired a five-year-old Boston company called Business Intelligence Advisors, which employs a number of former CIA and other national-security operatives to do behavioral analyses of corporate executives. The intent: to detect when managers are being less than candid or lying in their communications with shareholders, during interviews and quarterly earnings conference calls or even in press releases or management discussions in 10-Ks.

"The richer the medium, the better for detection," says the company co-founder and chairman, Liam Donohue, who also is a venture capitalist. "But our people can glean plenty of insight from heavily lawyered news releases as opposed to our being present during interviews or analyzing video or audio tapes."

The company also offers training seminars to teach security analysts, portfolio managers and, lately, corporate auditors detection techniques and how to ask questions that better elicit information.

But uncovering deceptive behavior -- regardless of whether it's executives being evasive or telling baldfaced lies to cover up a scandal -- remains the ne plus ultra of BIA's mission for the hedge-fund crowd. "This is information that's incredibly useful to anyone making high-stakes financial bets," boasts BIA's other founder, former corporate lawyer Cheryl Cook.

One hedge-fund analyst regularly uses BIA operatives (information "elicitors," in company jargon) to analyze the conference-call transcripts and press releases of companies that his hedge fund is shorting. He even had a Business Intelligence Advisors expert, posing as an assistant, accompany him to an interview with two executives from a financial-services concern in which his fund had a large short position. While he took notes on the interview, the BIA employee concentrated on just one thing -- the managers' verbal and nonverbal behavior. The BIA agent, unaware of whether the hedge fund was betting on, or against, the company, found both executives acting highly deceptively when discussing a number of key financial issues, such as possible shenanigans with their reserves.

The stock of the company in question -- the hedge-fund manager would speak with Barron's only if we wouldn't identify him, his firm or the stock -- has since fallen more than 25% and the analyst thinks it has a long way to go on the downside, despite a once avid bullish following on Wall Street, he contends.

"The value of BIA experts is both in their ability to confirm what one suspects and also indicate where in the financials one should drill down into," he explains. "Of course, all they can uncover is concern or deception. They can't tell you the degree of magnitude of any problem areas they detect."

Such services don't come cheap, but getting an exact figure is difficult, in part because they vary from job to job.

Most important to Business Intelligence Advisors -- which doesn't appear to have any rivals that do precisely what it does -- are language cues, mainly because printed or transcribed corporate communications are at times the only material its experts have to work with.

First, its specialists try to gauge whether managers definitively and directly answer questions and forthrightly address issues, rather than tap dance around the subjects. Among the verbal dodges they look for are managers' use of "protest" statements when confronting areas that make them uncomfortable instead of, say, firm denials of questionable behavior. Here, the term "protest" is used in the older sense of the word -- as an assertion or affirmation, rather than an objection.

The litany of common protestations is numbingly familiar to anyone who has a passing familiarity with corporate spin.

"Our accounting is in strict accordance with Generally Accepted Accounting Principles" has been asseverated by executives charged in every financial fraud during the Enron era. Likewise, fraudsters never tire of asserting that their companies' financials have passed muster by their accountants, rating agencies and regulators such as the Securities and Exchange Commission. Other bromides often evoked as protest statements are: "We have an experienced management team in place." Or perhaps, "Our business is extremely complex." And, finally: "We have a great business plan that will really start to deliver soon."

Protest statements, according to BIA operatives, fulfill a number of purposes beyond permitting executives to avoid giving factual answers. By invoking a higher authority such as GAAP, the managers hope to divert attention from problems and convey the sense that all is well with the company. At a minimum, protest statements imply a lack of comfort on given issues. At a maximum, they signal outright deception.

Other cues that BIA experts place a lot of stock in are management replies larded with irrelevant specifics, meant to obscure some troubling issue. Often the details are accurate as presented.

Qualifying words can be important also. When executives resort to such locutions as "candidly," "honestly" or "to tell the truth," watch out. They might be trying to manage perceptions rather than convey fact.

Ad hominem attacks on accusers are another staple of managements seeking to cover up problems and blunt charges. Typically, whistle-blowers and other critics are dismissed as "disgruntled former employees" or "cranks." The aim is both to impugn an accuser's credibility and to avoid having to directly deny the charges.

Nonverbal cues can also be important, though they are often subtle. For example, BIA officials assert that, in judging credibility, most people are overly biased by such nonrevelatory externals as lack of eye contact, apparent nervousness and posture. Instead, BIA looks for such indicators as what it calls "shifts in anchor points." Executive zingers are often proceeded by a sudden shift forward in body weight, for example. The onset of fidgeting -- such as playing with a water bottle or cup of coffee -- can likewise betoken acute discomfort in an executive. This is particularly telling if it contrasts with previous mannerisms and tics.

Examples of Business Intelligence Advisors' methodology are found in the company's main training video -- an April 2001 CNBC interview of Sanjay Kumar, then the CEO of Computer Associates, which is now called CA Inc. (ticker: CA).

At the time, the Business Intelligence Advisors staff had no way of knowing that, five years later, Kumar would plead guilty to securities fraud and obstruction of justice, stemming from the company's use of back-dated contracts to pump up quarterly sales and earnings over several years. The SEC and Justice Department didn't launch their investigations of Computer Associates until almost a year after BIA had begun using the video in the spring of 2001. What BIA operatives had seized on were Kumar's on-camera responses to questions that had been raised in a New York Times article. To the observers, they reeked of deception.

Recently, in a Business Intelligence Advisors conference room in Herndon, Va., one of the company's experts ran through the video for Barron's, pointing out various cues or "tells" that, she asserted, had pointed toward deception.

The expert -- we agreed to call her by the pseudonym Grace -- a trim woman who, following graduation from Duke (with a double major in history and psychology), worked 20 years as a CIA interrogator. "No rubber hoses or other coercive techniques," she offers with a dismissive chuckle. "Duress just raises people's defenses. You catch a lot more flies with honey, rather than vinegar."

Early on in the interview, Kumar sedulously fires off protest statement after protest statement, rather than strongly denying the charges of dodgy accounting. To wit, he declares, Computer Associates accounting methodology met the strict GAAP standards "that we all live by" and, he adds, were blessed by two accounting firms.

Then CNBC interviewer Bill Griffeth gives Kumar a temporary out by talking about the revenue-growth problems that technology companies in general were having in the then-tough economic environment. Kumar seizes the opportunity to go off on a long riff about general industry difficulties. "He's trying to divert attention away from Computer Associates and run the clock out on Griffeth," Grace comments.

A trained "elicitor" pays close attention to the unwitting cues in the interview. At one point, Kumar grandly declares that there's "nothing wrong fundamentally" with the company's business practices. "Oh, really?" Grace interjects after freeze-framing the interview DVD. "That qualifier 'fundamentally' shows a real lack of conviction on his part. It implies that problems exist in at least some areas of the culture."

In due course, Kumar resorted to the tried and true tactic of smearing the accuser, the New York Times, to shake viewer confidence in the veracity of the article. After saying that there's no point in playing "tit for tat" with a company that buys paper by the ton and ink by the barrel, he proceeds to do precisely that. He complains that the article had no named sources, save a couple of small commercial customers. "Incredibly," Kumar adds, the reporters hadn't contacted any Wall Street securities analysts, who, of course, "know the company well." Moreover, the Times article is completely "devoid of factual reporting."

Grace moves on to another training DVD -- Bill Clinton's famous 1992 60 Minutes interview, just before the New Hampshire primary and right after widespread publicity about Gennifer Flowers' adultery charges against him had imperiled his chances for the Democratic presidential nomination.

The moment of truth comes when Clinton is asked whether he denied having had a liaison with Flowers. His reply: Both he and she previously had denied such an involvement. In Grace's view, it was a classic "non-denial denial." Clinton was to make use of the strategy again, especially when the Monica Lewinsky story broke with such ferocity.

Grace, however, points out other interesting aspects of the 60 Minutes segment, including some involving Clinton's now-famous wife. "Watch the behavior of Hillary closely, when the key question comes up," she says.

Mrs. Clinton, sitting next to her husband, had been nodding in an exaggerated metronomic fashion during the interview, in apparent approbation and support of her spouse. But Bill Clinton's answer about Flowers seems to momentarily knock her off stride. She shifts position and glances quickly at him before resuming her nods. "Something clearly upset her," Grace maintains. "Maybe he didn't give the answer she expected or deviated from the script."

Next on the hit parade is a Scott Peterson interview with ABC Television's Diane Sawyer, done in January 2003, about a month after his wife Laci was reported missing.

According to Grace, Peterson's dissimulation is obvious throughout the interview. For example, he involuntarily smirks for a brief moment after he denies to Sawyer that he murdered his wife. At another point, he closes his eyes ("Just like Jeff Skilling did when testifying before Congress on the collapse of Enron") immediately before telling what later turned out to be a lie.

Peterson answers promptly with a convincing "no" when asked if he'd had extramarital affairs, other than one he admitted to with Amber Frey. But he stumbles badly when asked if he'd ever beaten Laci. "Violence towards women is unapproachable," he replies, somewhat incoherently, evading the question.

Later, Peterson doesn't mention Laci when apologizing to both his and Frey's family for his affair with Frey. "Don't forget that, at that time, Laci was only missing, so the omission indicates that he knew she was dead," Grace asserts.

Of course, behavior analysis is easier after the fact; we all know that Scott Peterson was found guilty. But Business Intelligence Advisors has had some great calls beyond Sanjay Kumar.

Another hedge-fund manager furnished Barron's with the company's analysis of bond insurer MBIA's press release responding to an April 2005 Barron's article accusing the company of accounting manipulation and inadequate loss-reserving, among other issues.

The report proved to be prescient. For example, it predicted that three reinsurance contracts that the company had used in 1998 to cover up a nasty $170 million claims loss would cause MBIA additional problems, even though the insurer already had voided $70 million of the $170 million in contracts and taken an appropriate earnings hit. Indeed, by the end of 2005, the remaining contracts also were voided, further hurting earnings.

The Business Intelligence Advisors analysts found indications of the additional problems in the release's wording. In one section, MBIA claimed that the investigation of the three deals was "substantially complete." To the analysts, "substantially" set off alarms.

The MBIA release also went into numbing detail as to the scope of the investigation, describing who had been interviewed and listing the documents that had been reviewed. These, according to BIA, were mere "specifics" designed to impress Wall Street while artfully sidestepping the central issues.

The release was also larded with qualifiers that, the analysts suspected, implied a lack of conviction on MBIA's part. For example, MBIA stated that it "believed" that its claims reserves were adequate. That's a weasel word. In fact, the reserves, unallocated to specific losses, have been dropping precipitously ever since, leading some critics of the company to predict that it might be facing a big reserve charge.

Business Intelligence Advisors also noted that while MBIA asserted that Barron's had created "many misimpressions," the company's response noticeably failed to rebut the article's main allegation that MBIA had manipulated earnings. Stay tuned on that score.

The stock (ticker: MBI), though currently trading in the 50s, around the same level as when the Barron's story appeared, remains under a cloud. MBIA is being investigated by the SEC, the Justice Department and the New York Attorney General's Office.

Other reports obtained from third parties show interesting assessments of different managements' credibility. For example, JPMorgan Chase (JPM) CEO Jamie Dimon scores fairly well on the candor front in a recent earnings conference call by forthrightly dealing with his concerns over the bank's credit-card growth and the likely rise in nonperforming commercial loans.

The same can't be said for the management of Kodak (EK). BIA analysts contend that Kodak executives, in their latest earnings conference call, were less than open about the company's back-to-school sales prospects, in-store kiosk results and campaign to boost operating margins. And, as if General Motors (GM) didn't have enough problems, the analysts give its management low marks for openness and credibility.

To be sure, there's an element of hocus-pocus in BIA's techniques. The company is secretive about many aspects of its methodology. And there's often a big difference between evasiveness and lying. But BIA doesn't overpromise. "We're more compasses for clients than human lie detectors," Grace comments.

Even so, BIA should have a bright future. After all, gilding the lily and spinning perceptions will never go out of style, especially on Wall Street.
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