MacGuide Securities Class Action

Hundreds of people lost all their money when they invested in a penny stock IPO of a bankrupt company underwritten by a penny stock brokerage firm or by purchasing in the aftermarket from a number of different brokers.

I filed a case for securities fraud and racketeering against MacGuide Magazine, Inc., its CEO, the large downtown firm that was its securities counsel,and the international public accounting giant that audited MacGuide’s financials. Also named were the underwriter, the penny stock firm of R. B. Marich, Inc., its CEO Rudy Marich, underwriter’s counsel.

The case was high profile and somewhat controversial. For the first time, my name appeared on the front page of the financial news in the Denver newspapers where it would appear several more times. It was my first class action so I was required to team up with experienced class action counsel to get the case certified by the court.

The case began in 1989 and was completed in 1993. Even a successful class action is very rigorous for the people representing the class, the class representatives and attorneys, because they are the people with the most “skin in the game.”

In this case, smart engineering of the claims and thorough investigation resulted in a substantial recovery. I constructed a case against the public accounting firm and lawyers involved in the offering using secondary liability – the liability of those who enable or aid illegal conduct other then the primary wrongdoer.

The defendants pretended they could not understand why there was any problem at all. There were motions to dismiss and motions for sanctions against our team for filing a frivolous case. As is common, these motions are based on very disingenuous interpretations of the complaint and dubious legal arguments, the stock in trade of many white collar defense lawyers. To me, when the defendants harrass me, it is a cue that they must be very vulnerable. Moreover, responses to dumb motions to dismiss are a great opportunity to coach up the judge on the merits of your case and damage your opponent’s credibility, and this is what I did.

Our case was not the least bit far fetched. It was initially presented to me by a disgruntled ex-employee, a whistleblower. Once MacGuide stopped making payroll there would be more whistleblowers. The newspaper coverage motivated victims to help. Documents flooded into the office. Many witnesses came forth and were interviewed. The facts and law were extensively gathered, researched and documented. Our case boiled down to the simple facts that MacGuide lied about its circulation and advertising revenue, drastically inlating them, and the underwriter, public accountants, and the lawyers knew and concealed it or recklessly disregarded obvious red flags and failed to investigate and disclose the true facts.  

MacGuide magazine had only a fraction of the paid subscriptions it claimed in its prospectus. MacGuide claimed paid subscriptions equivalent to the number of copies it printed. The US postal service had the actual circulation figures and gave them to me. The actual figures were much lower than those claimed.

Whistleblowers told me that MacGuide could not give the magazine away. Skid loads of magazines were left disposed of at random places, like a parking lot. Even Apple rejected thousands of free magazines MacGuide wanted to leave for Apple employees at its Cupertino headquarters. Apple was upset that MacGuide was deceptively trading on the Apple and MacIntosh names and the trademarked bitten-apple logo. Apple’s intellectual property lawyers sent a cease and desist letter threatening suit against MacGuide. When Steve Jobs refused to endorse their magazine, the employees of MacGuide were crestfallen. They revered the Apple founder.

I was told by another whistleblower that MacGuide was so strapped for cash and the magazine so bereft of paid advertising that the company bartered ad space for equipment and supplies.

The public accounting firm recklessly failed to protect the investing public by failing to report the circulation and advertising revenue fairly and accurately. From working with public accounting firms on many public offerings and annual reports, I have developed a good understanding of the auditing process. From reading the audit work papers, I could see that there were smoking guns everywhere that the accountants overlooked when it green-lighted the offering with a clean audit opinion and a so-called “comfort letter” updating the opinion as of the closing.

An audit opinion is like a paid testimonial that the figures are correct. It is supposed to be the gold standard for presentation of financial information. Under the accountant’s imprimatur, MacGuide had been able to claim grossly inflated advertising revenue, determined by multiplying the list prices for the size of the ad space it bartered, which in turn were based on inflated ciruclation. This violated auditing standards. In barter transactions, where the value of the ad space is sketchy, public accounting firms should use the much lower value of the equipment and supplies received in exchange. Not to mention the red flag that a publisher that has to give away almost all of its space for things like pens and paper is desperate, obviously.

This brought to mind another case when the auditing firm for a company called Storage Technology was found liable to investors for a blown audit. The value of Storage Tech’s inventory of storage devices as presented in the financials included boxes of bricks employees boxed up to look like storage devices, ready to ship. This happened here in Colorado. Storage Tech’s CEO at that time was Q. T. Wiles, a name somewhat reminiscent of the hapless cartoon villain, Wile E. Coyote.

The public accounting firm also violated auditing standards by using exceptionally flimsy evidence to back up key figures. One example: their reliance on management’s statements where they were contradicted by documents or readily observable facts. Worse yet for this firm, in the audit accompanying the first annual report after the public offering, the firm gave MacGuide’s financials the dreaded “going concern” opinion for some of the very reasons cited in the complaint — no revenue, cash, circulation, advertising, etc.

Insofar as the prospectus prepared by MacGuide’s attorneys failed to make adequate risk disclosure (providing only boilerplate or hedged statements that were too positive) and parroted incorrect facts and figures from the financials, the lawyer’s closing opinion on the accuracy of the prospectus was false and given in reckless disregard for investors. The underwriter’s counsel also had to get a failing grade in “due diligence” if they could not figure out what I could readily see from looking at the same documents they had.

My take was that the IPO should never have closed. CPA’s and securities lawyers have obligations that sometimes transcend pleasing the client by doing whatever the client wants done. Pandering to a client, rather than digging in and insisting on appropriate corrective action and fixes, can be very destructive for both the client and your professional practice.

The Comfort Letter, a 1975 novel by Arthur R. G. Solmssen, a wise Wall Street lawyer, has been a big influence on my professional perspective. It tells a dramatic story culminating in a “to close or not to close dilemma” facing a fictional securities lawyer, Ordway Smith.  Smith, put under tremendours pressure to close a public offering from his firm's client, the investment banker and his firm, instead stops it from closing for the good reason that the issuing company was a house of cards.

For MacGuide, the jig was up once I filed the complaint and the case made the headlines. The company filed for bankruptcy. The CEO of the underwriter failed to appear at the mandatory pre-trial conference. His lawyer had a doctor’s note saying that due to recent back surgery his recovery would be jeopardized by the rigors of trial. The sympathetic judge reset the case for the following year.

But there was to be no trial. More than one million dollars in settlements was recovered from the firms that insured the accounting giant and downtown lawyers.