Thursday, September 28, 2006

Where’s Sammy Antar When You Need Him?

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How Merck Saved $1.5 Billion Paying Itself for Drug Patents

Partnership With British Bank Moved Liabilities Offshore; Alarmed U.S. Cracks Down


Those are the Wall Street Journal headlines, and they certainly seem terrible for the folks from Whitehouse Station, New Jersey.

Here are the details:


Thirteen years ago, Merck set up a subsidiary with an address in tax-friendly Bermuda, in partnership with a British bank. Merck quietly transferred patents underlying the blockbuster drugs to the new subsidiary, according to documents and people familiar with the transaction. Merck then paid the subsidiary for use of the patents.

The arrangement in effect allowed some of the profits to disappear into a kind of Bermuda triangle between different tax jurisdictions. The setup helped Merck slash $1.5 billion off its federal tax bills over roughly the next 10 years.

Sounds bad, huh?

Actually, I’d bet the ranks of companies that engage in same kind of offshore asset-shuffling tax-minimization that the Merck guys used include nearly every member of Fortune 500, and a few others too boot.

But instead of taking that bet, I’d suggest asking Sam E. Antar, the former Chief Financial Officer of one of the all-time great accounting scams—Crazy Eddie.

Sam is a self-described “reformed criminal” who now has a web site (http://whitecollarfraud.com) designed to offer guidance on how to “Protect Yourself against White Collar Crime.”


I know this because Sam posted a comment on this blog recently. (See "Tom Joad's Truck.") It had been about twenty years since I'd heard anything about Sam, which was back when Crazy Eddie was the hottest retailer on Wall Street and before the fraud was discovered.

In those pre-Eddie-Antar's-flight-to-Israel-days, Wall Street’s Finest had been rightly skeptical of Crazy Eddie at first blush, but the company kept blowing out earnings after earnings, which eventually created the kind of momentum that causes suspended disbelief among rational people—so much so that Crazy Eddie himself was the featured luncheon speaker at a giant retailing conference here in Manhattan, hosted by one of Wall Street's Finest.

The presentation started with an emotional introduction by Jerry Carroll, the pitchman whose radio and TV commercials (“His prices are insane!”) made Crazy Eddie famous. Carroll introduced Eddie, they hugged, and then Eddie began a fast-talking pitch for the company to a ballroom filled with enthralled money managers and jealous competitors.

During the question and answer session, somebody asked Sammy, the CFO, what the company did to keep its tax rate lower than other retailers. This is, usually, a softball question that triggers, usually, a bland and highly generic sort of answer about how ‘we work hard to minimize taxes in a variety of ways…yadda yadda yadda.’ Usually.

But Sam didn’t yadda yadda yadda.

Instead, he launched into chapter and verse about how they registered trade names in low-tax jurisdictions and also, if I remember correctly, something about running products through low-tax jurisdictions in the same sort of way Merck apparently did with its drugs.

I don’t recall all the details, but I vividly remember sitting at a lunch table with the folks at Toys “R” Us, who immediately began making eye contact, shaking their heads and rolling their eyes at each other.

I whispered to the Toys “R” Us guy sitting next to me, “I take it you guys do that too?”

He said, “Yeah, but we don’t talk about it!”

That was twenty years ago. So I have to ask this: why did it take the U.S. so long to get “alarmed” at this kind of stuff?

Sam, you got any ideas?


Jeff Matthews
I Am Not Making This Up

© 2006 Jeff Matthews

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations. This commentary in no way constitutes a solicitation of business or investment advice. It is intended solely for the entertainment of the reader, and the author.

6 comments:

RichL said...

And if the money from making drugs or building I-Pods (or any other property built overseas and sold in the US) is funnelled into low tax jurisdictions by booking profits there and away from the US, guess what happens to the US trade deficit?

To the moon, Alice! (This, BTW, is Andy Kessler's idea.)

Corporate America gets a low tax rate, and the US trade numbers look like death due to this. All because the US has the best government that money can buy.

Sam E. Antar said...

When God forbid a plane crashes the Federal Aviation Authority will investigate the accident in minute detail, make recommendations, and seek to have changes made so that measures are undertaken to prevent future accidents.

Unfortunately, the same does not apply to the issue of white collar crime. I would have to believe that most persons at the internal revenue service who investigate such tax matters are accountants (majored in college) and CPAs.

The problem begins with their education during their college years as they seek to graduate with a major in accounting and hope to eventually become CPAs.

Most accounting students never take a fraud course in college, let alone a specific course in securities fraud or internal controls. Many other key important subjects such as the above and are covered on the CPA exam. However, accounting students must learn these areas in a CPA (cram review course) since they never learn such subjects in college. In addition they never learn about criminology (which is not covered on the CPA exam).

If these accounting students eventually become CPAs, the current recommendation of the American Institute of Certified Public Accountants is that they take only 10% of their continuing education course credits in the area of fraud (at most 4 hours a year of a 40 hour per year continuing education requirement.

In fact many states require CPAs to take more ethic courses than fraud courses as they continue in the profession and meet their required continuing education requirements. Personally speaking, ethics courses do not change “would be” criminals to “to become clean” and is no more a means of “preaching to the choir” for the overwhelmingly honest people taking such courses.

With the above issues in mind I can address your question:

“So I have to ask this: why did it take the U.S. so long to get “alarmed” at this kind of stuff”?

The issue is fundamental to the education that accounting students get in their formative years in college as they seek to enter the profession whether at CPA firms, government (for example the IRS), private industry, and the nonprofit sector.

As major frauds come and go, whether they are financial frauds or tax fraud, most of the detail information about these schemes is never communicated to the profession at large. Worse yet few steps are taken to prevent future scams based on the information obtained from investigating these crimes.

So you write:

“I’d suggest asking Sam E. Antar, the former Chief Financial Officer of one of the all-time great accounting scams—Crazy Eddie.”

Criminals always have the initiative and the professions approach to preventing fraud (whether as CPAs ay accounting firms, accountants in government, the private sector, and nonprofit sector) is “process oriented” rather than the criminal who approaches his work in a judgmental way.

Therefore, the criminal has the fundamental advantage against the under informed, not very well trained accounting profession in regards to combating white collar crime.

For example in the Crazy Eddie fraud, the auditors did not observe the year end inventory at all store and warehouse locations. We new in advance what locations would be observed or tested by the auditors as to accuracy. In this aspect of our fraud we simply increased the value of our inventory in the locations that the auditors did not observe – plain and simple.

A recent article by Joseph T. Wells in the Auditor’s Report entitled “What Accounting Students Need to Know about Fraud” published in their Summer 2006 edition told about a fraud committed by a company named “Phar-Mor” about 15 years after the Crazy Eddie fraud:

“…in the $500 million Phar-Mor fraud, auditors only tested a handful of stores out of 300. But they advised management months in advance on which stores would be tested. Not surprisingly, the selected stores were squeaky clean.”

You would think that most accountants would be have learned the lesson of the Crazy Eddie fraud – count all inventory locations and count them all simultaneously. Both accounting firms that audited Crazy Eddie and Phar-Mor were among the “big 4” accounting firms today. The gatekeepers (our audit firms) learned very little and the criminals once again out foxed them.

The same issue can be applied to the government accountants many of whom learn little about the details of previous fraudulent schemes (tax fraud or financial fraud) that affect their responsibilities.

I doubt today that intricate details about happened with regards to Merck’s tax issues, whatever fraud were committed at companies like WorldCom, Enron, Phar-Mor, and other countless companies will ever reach most of our future accountants under the cautionary subject ”lessons to be learned.” Very few steps will be taken with regards to legislation, auditing rules and procedures, and education to prevent future frauds such as the above from happening again.

After all most accountants think in terms of complying with “out-dated” audit programs (process oriented) and criminal’s who always have the “initiative” will be ever more thoughtful in thinking of new schemes and worst yet continue to use old schemes as they outwit the both government auditors and public accounting firms.

There is a wise saying “know thy enemy.” Until accountants in and out of government better understand issues of fraud and criminality there can be no effective prevention.

You wrote:

“Actually, I’d bet the ranks of companies that engage in same kind of offshore asset-shuffling tax-minimization that the Merck guys used include nearly every member of Fortune 500, and a few others too boot.”

You are probably correct. However, when you mention this issue and how I handled the question about minimizing taxes at a Wall Street conference a major tax fraud committed by Crazy Eddie over a 15 year period comes to mind.

For almost 15 years the Antar family (Eddie Antar, his father Sam M. Antar and other members of their family) skimmed over $15 million from Crazy Eddie. No one ever knew about this fraud until disclosed by me after the government had investigated the case for two years and cornered me into “cooperating.”

Today we have an underground economy in proportion to the Gross Domestic Product as large as it ever was during the hey-day of our skimming from the company in the 1970’s and 1980’s.

So when you aptly ask about the Merck tax scheme:

"That was twenty years ago. So I have to ask this: why did it take the U.S. so long to get 'alarmed' at this kind of stuff?"

And you write:

"I’d suggest asking Sam E. Antar...."

I say to you that the Sam E. Antar of twenty years ago (I am not a criminal today) would be just as successful in today’s environment.

Other than Sarbanes-Oxley and its limited reforms (which many misguided detractors are trying to weaken today), little progress has been made in the culture and attitude of the accounting profession (in private industry or government) regarding white collar crime.

That is why in a head to head battle with the “evil genius of Sam E. Antar of yesteryear” they would still be no match for me today.

Remember that most financial frauds are still uncovered today as a result of informants and not as a result of any proactive action by accountants and auditors in and out of government. Worst of all such frauds are caught AFTER major collective damage has been inflicted on the innocent.

Respectfully, Sam E. Antar “is not making this up” too.

pboni said...

Funny that you use the word "fraud" to describe this.

A few years ago, as a buyside analyst, I noticed that one of the companies I was looking at had a significant amount of their cash resources in offshore jurisdictions, as a result of this kind of tax planning. I called the CFO and asked about it - "if you want to spend this money domestically, or give it back to shareholders, you would have to bring it back to the US and take pay full tax on the earnings, wouldn't you?" His answer was - you are correct, but we'll probably get a tax amnesty in the next few years and it won't be a problem.

Well, I don't know if he had "inside information" on this topic or not - but he got his amnesty in the form of the American Jobs Creation Act of 2004. I found it ironic that people were praising all the money that was being repatriated - since without the amnesty they might have to pay full tax to bring it back in.

My point is, this isn't fraud, this is how the system is set up. Why are people getting alarmed now? Could it be election season fodder?

Sam E. Antar said...

The Rest of the Story:

Your comment below is well noted:

“In those pre-Eddie-Antar's-flight-to-Israel-days, Wall Street’s Finest had been rightly skeptical of Crazy Eddie at first blush, but the company kept blowing out earnings after earnings, which eventually created the kind of momentum that causes suspended disbelief among rational people—so much so that Crazy Eddie himself was the featured luncheon speaker at a giant retailing conference here in Manhattan, hosted by one of Wall Street's Finest.”

The fact is that there were many skeptics about Crazy Eddie at first. Barron’s ran a great story prior to the initial public offering raising many issues about the planned initial public offering. The problem is that many early skeptics became intoxicated with Crazy Eddie’s continuing “blow out earnings” reports. These skeptics as a result of this intoxication lost their professional skepticism and required degree of on cynicism.

‘Crazy’ Eddie Antar used to advise me that “people live on hope.” The Wall Street analysts and external auditors whose job it was to be such skeptics became so engrossed and obsessed in the supposed success story of Crazy Eddie that they lost their required professionalism and became unable to carefully examine “red flags” that were plainly visible.

I have often said that white collar criminals use your humanity against you. Such an understanding of the motivations and techniques of white collar criminals, however, is severely lacking in the education, training, and skills of our external auditors (the gatekeepers), the financial analysts on Wall Street, and the accounting profession.

Until the guardians of capitalism (our accounting profession and the financial analysts on Wall Street) learn about how they can be manipulated by criminals many preventable frauds will continue to destroy the main pillar of which our free market capitalist economic system is based – the integrity of financial information.

Respectfully,

Sam E. Antar

Its_strange said...

Looks to me Sam Anter would do a world of good if he would read Herb Greenberg's stuff and post on the respective yahoo board.

Sam S. Park said...

I agree, to a certain degree, with Sam E Antar's point that many are uninformed and unequipped to catch the warning signs. However, the rising number of financial shenanigan coming to surface has led to certain programs (like the CFA curriculum) to add some emphasis on the matter. Then again, I'm not sure how much can be blamed on insufficient number of people that understand how numbers can be taken off the books (by applying extremely aggressive accounting methods or outright fraud). Sometimes, it's just laziness or greed of the due diligence processor or auditor for not catching the problem. And perhaps other times, it's simply being awed by the magician who has fooled the audience by refocusing their attention elsewhere.

Magic tricks aren't that impressive when you know how the tricks are really done. Some magic illusions may be interesting, but I think the majority will catch-on to the lame and cheap tricks. Maybe many have not caught on to the act so far... but this will likely reverse. Jeff points out that most companies conduct some shady (aggressive) accounting techniques, but how many people really want to spend all that time digging into these matters deeper... oh wait, isn't this the job of the "Wall Street’s Finest?” But this is a point that I’m going to avoid.

Here’s what I really want to know: What is the fine line between creative strategizing and manipulative fraud? And this question isn’t limited to accounting scandals. For instance, how many hedge funds engage in borderline manipulative practices vs. those strategizing legitimately? But let’s avoid talking about Naked Shorting again.