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Failure to Disclose

On August 30, the Ontario Securities Commission (OSC) issued a Notice of Hearing to Philip Services Corp., the predecessor of the current Philip Services Corporation, regarding one of the largest alle...


On August 30, the Ontario Securities Commission (OSC) issued a Notice of Hearing to Philip Services Corp., the predecessor of the current Philip Services Corporation, regarding one of the largest alleged securities frauds in Canadian history — estimated at US$363-million.

On June 25, 1999, the predecessor Philip and its subsidiaries filed a voluntary petition under Chapter 11 of the US Bankruptcy Code. Assets and liabilities were transferred to the new company, which emerged on April 7, 2000.

The OSC — which spent two years preparing its case — alleges that a prospectus filed by the predecessor Philip in November 1997 failed to provide full disclosure of all special charges, which were subsequently recorded. The OSC has accused seven executives — including co-founders Allen and Philip Fracassi and metals division head Robert (Bobby) Waxman — of misleading investors by hiding the financial condition of the company in documents supporting a 1997 stock issue. The OSC alleges that Bobby Waxman was relieved of his duties in October 1997 but Philip’s board was not told about this until after the share issue.

If found guilty, the executives could be banned for life from holding jobs as managers or directors of public companies and could be forced to pay the costs of the investigation (approximately CDN$1-million).

The other executives include Marvin Boughton, who was executive vice president and chief financial officer of Philip. (Mr. Boughton is a chartered accountant who, prior to joining Philip in or around 1991, was a partner in the accounting firm of Deloitte & Touche in its Hamilton, Ontario office where he had been employed for about 32 years. Deloitte was also Philip’s auditor.) Graham Hoey was senior vice president, finance and also formerly a partner with Deloitte. Colin Soule was the general counsel, executive vice president and corporate secretary. John Woodcroft was executive vice president, operations.

The share sale

Shortly after it released its prospectus in November 1997 the company restated its 1995 and 1996 financial results, admitting to losses of $16.8-million. The OSC alleges the company knew about problems as early as September 1997 but didn’t tell investors until January 1998, weeks after the stock had been sold.

At the time of the share offering, Philip described itself as “one of North America’s leading suppliers of metals recovery and industrial services.” For the year ended December 31, 1997, the company reported revenues of US $1.75 billion, of which US $1.1 billion was attributed to the company’s metals recovery group.

On November 6, 1997, Philip made a public offering of 20 million common shares. Fifteen million were sold in the United States and five million in Canada and abroad. The offering raised about $364-million and closed on or about November 12, 1997. The price per each offered common share was $16.50. The prospectus that was filed with the offering included Philip’s audited financial statements for the years ended December 31, 1996 and 1995, for which Deloitte had issued unqualified audit opinions. The prospectus also contained other unaudited interim financial statements. Philip entered into an underwriting agreement with a syndicate led by Salomon Brothers Inc. and Merrill Lynch & Co.

“Mr. Waxman had improperly obtained payment for a number of expenses … with no legitimate business purpose, such as golf, rare wines and airfare for his wife on the Concorde.”

In a press release dated November 5, 1997, Philip reported record net earnings of $25.4-million for the three month period ended September 30, 1997 — a 105 per cent increase over the $12.4-million from continuing operations for the same period in 1996. It also reported that its revenues for the three-month period increased 246 per cent to $502.2-million (from $145.2-million for the same quarter in 1996). This financial information was incorporated into the prospectus.

Specific allegations

The allegations advanced by OSC staff center on the company’s failure to provide full disclosure in its November 5, 1997 prospectus of material facts concerning Bobby Waxman’s departure, as well as other facts.

Mr. Waxman became a Philip director in January 1994 after Philip acquired that business and he was made president of the metals group in February 1996. In mid-September 1997 he was relieved of all his duties and operating authority. However, Philip tried to cover up the fact that Mr. Waxman had been fired and owed the company money.

In a representation letter dated November 6, 1997 (the same date that the prospectus was filed) Mr. Fracassi and Mr. Boughton wrote: “No shortages or irregularities have been discovered that have not been disclosed to you and to our knowledge there is nothing reflecting upon the honesty or integrity of personnel of our organization.”

The OSC says that on January 5, 1998 the company misrepresented the nature and timing of Mr. Waxman’s firing in a news release. Mr. Waxman’s departure was announced as a “resignation” that was part of Philip’s “consolidation and restructuring program” effective on the date of the news release.

The pertinent facts about Mr. Waxman that weren’t disclosed in Philip’s share prospectus relate primarily to four allegations:

1. Financial losses incurred by Philip of approximately $20-million allegedly caused by Mr. Waxman in connection with various unauthorized transactions;

2. Mr. Waxman being relieved of his duties and all operating authority in mid-September, 1997;

3. A $10-million promissory note executed by Mr. Waxman on or about October 28, 1997, in favour of the company, and

4. Mr. Waxman’s admission in mid-September, 1997 that he had derived a personal benefit of approximately $2-million from certain unauthorized transactions he had instituted on behalf of Philip.

The OSC also alleges that the executives failed to disclose special charges in the prospectus. These include a restructuring charge in the amount of $155.7-million, which was not disclosed until 1998, mostly for costs that were identified prior to September 30, 1997.

The OSC also alleges that Philip’s prospectus did not include information about financial transactions of approximately $110-million (of the total $234.9-million in charges later taken by Philip). These transactions were dealt with as “special charges” at the end of 1997 — after completion of the share sale — to deal with various accounting irregularities.

The financial transactions were comprised of:

1. Approximately $31-million for holding certificates in respect of inventory, which were issued by Philip in 1996 and improperly recorded because Philip failed to record the underlying transactions as liabilities or, alternatively, failed to remove the inventory from the accounting records;

2. About $29-million of unrecorded liabilities for invoices issued by its customer, Pechiney World Trade Inc., in 1996 and settled by Philip in 1997;

3. Approximately $30.2-million regarding a financing arrangement between Philip and Commodity Capital Group, finalized on or about August 13, 1997;

4. Roughly $10-million regarding a financing arrangement between Philip and the Canadian Imperial Bank of Commerce, finalized on or about June 27, 1997, which was not properly recorded in the financial statements; and

5. The $10-million promissory note from Mr. Waxman that was improperly recorded in the financial statements in inventory.

Damage control

On January 26, 1998, approximately 11 weeks after the November share offering closed, Philip announced the $155.7-million restructuring charge (which included a write-down of goodwill) and the “special charges” (that addressed the copper inventory problems). The company issued further clarifications the following day. The goodwill write-down related to a number of acquisitions concluded between 1993 and 1996. The physical inventory adjustment — approximately $60-million after-tax — involved the difference between book inventory and physical
inventor
y in the metals group copper-yard business.

The revelations and clarifications pummeled the company’s stock price. For instance, on January 23, 1998, the closing price for Philip shares on the TSE was $18.90. Five days later, following the announcements, the shares closed at just above $12. (The company’s stock would eventually sink below one dollar.)

On March 5, 1998, Philip announced its financial results for the year ending December 31, 1997 and the results of an audit conducted by external auditors into the copper inventory discrepancy. In a press release the company announced a $185.4-million (pre-tax) one-time charge related to the write-down of certain assets. It reported a loss of $95.8-million and restated its earnings for 1995 to $3.2-million (rather than approximately CDN$32.7-million as originally disclosed) and for 1996 to a $20-million loss (rather than a profit of approximately $39-million as originally disclosed).

In the end, the company quantified the discrepancy in the copper inventory at $92-million (resulting from trading losses) and $32.9-million caused by incorrect recording of copper transactions. The losses were incurred over a three-year period as a result of speculative transactions done outside of Philip’s normal business practices.

At the end of March 1998, Philip reported that an additional charge of $13.6-million had to be added to the special and non-recurring charges of $185.4-million disclosed in its March 5 press release. This included $10-million in unrealized losses from copper swap contracts and $3.6-million in “other” costs relating to copper operations.

Further clarifications from the company followed.

Waxman termination

Bobby Waxman began working in the scrap metals industry for I. Waxman & Sons Limited (IW&S) in 1973. In September 1993, IW&S rolled its active operating assets into Waxman Resources Inc. and then sold all of the shares of Resources to Philip. Mr. Waxman became a director of Philip in January 1994 approximately two years later was made president of the metals group.

According to the OSC allegations, at all material times Mr. Waxman reported to Allen Fracassi on a day-to-day basis, as well as to Philip Fracassi and John Woodcroft. By 1996 the metals group accounted for approximately 60 per cent of Philip’s revenues. Bobby Waxman is described on page 67 of the November share prospectus as “President, Metals Recovery Group and Director” and is described elsewhere in the document as a long-term Philip executive. The only disclosure in the prospectus regarding indebtedness to Philip by any company executive during the relevant time period was CDN$737,200 loaned to Allen Fracassi for the purpose of purchasing a home.

In early 1997, the vice president of finance in the metals group commenced an investigation into various copper cathode transactions. In June, Mr. Woodcroft and Mr. Fracassi were advised of suspicions about Mr. Waxman’s involvement in the removal of copper cathode from Philip’s account. A memo dated May 22, 1997, also advised that Mr. Waxman had improperly obtained payment for a number of expenses unrelated to Philip, and with no legitimate business purpose, such as golf, rare wines and airfare for his wife on the Concorde. On July 7, 1997, the company cancelled his company credit card.

In June 1997, Philip’s executive vice president for corporate and government affairs received information about a “shrinkage program” attempted by Mr. Waxman and an employee who reported to him to improperly divert Philip inventory. Other allegations were advanced regarding inappropriate copper cathode transactions being effected in the metals group. (See sidebar, pg.59)

A handwritten memo dated September 12, 1997 to Allen Fracassi advises of four transactions “controlled by Bob Waxman which appear[ed] to be of a fraudulent nature.” One of them was described as follows: “During the one year period ended March 97 we lost US 10.0 million on cathode sales to Parametal Trading. These were predominantly paper, non-physical transactions. There is no valid reason, including borrowing, hedging or outright speculating that could explain a loss of this size based upon the average monthly trading volume of US$10-million. The only logical conclusion is that money is being taken from the Company.”

The memo described three other, similar schemes and concluded, “Bob [Waxman] must not be allowed to enter into any transactions. All people loyal to him should be fired and we should try to recover whatever we can without having the whole thing blow up.”

“If found guilty, the executives could be banned for life from holding jobs as managers or directors of public companies and could be forced to pay the costs of the investigation.”

In mid-September 1997, Mr. Waxman admitted that he had derived a personal benefit of $2-million from certain transactions and was soon after relieved of his duties. Notwithstanding this, the OSC allegations state that Mr. Waxman, “continued to be held out, by Messrs. A. Fracassi, P. Fracassi, Soule, Waxman and Woodcroft, as President of the Metals Group to the remaining members of Philip’s Board of Directors, other members of senior management, the employees of Philip and the general public.”

In fact, Mr. Waxman continued to attend board meetings, represented the company in connection with the finalization of certain acquisitions and executed the November share-offering certificate on behalf of Philip’s board.

The OSC alleges that Philip ignored the advice of its own lawyers — that Mr. Waxman’s firing, the reasons behind the firing, and Mr. Waxman’s promissory note to Philip were all of material significance to shareholders and should have been made public. The OSC charges that Philip kept all these things secret because it wanted its November share offering to be successful and didn’t want to scare away potential investors.

At a pre-hearing meeting held in Toronto on September 17, OSC lawyers stated they would disclose documents to the defendants by early December or sooner if possible. All parties will meet for two weeks in mid-April 2001, then reconvene in September for the full hearing.

Guy Crittenden is editor-in-chief of this magazine.


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