by Eamon Javers
Lu couldn’t know that the phone call was also being patched into a room thousands of miles away where interrogators trained by the CIA would analyze each inflection in Lu’s voice. The analysts were human lie detectors, working for Business Intelligence Advisors (BIA), a company with deep connections to the CIA. They were trying to find out whether Lu was telling the whole truth about UTStarcom’s financial health. When they came to their conclusion, they’d report it to BIA’s client, an enormous hedge fund. The secret intelligence they produced would help the hedge fund decide whether to buy or sell UTStarcom stock. If the intelligence analysts did their jobs, the hedge fund would be far ahead of the rest of the market. The information they gleaned from this phone call could be worth millions of dollars.
Earnings calls are an important Wall Street ritual. They’re a direct line from the corporate boardroom to the trading floor, allowing the company to put its best spin on the events of the quarter and give investors a sense of where it is headed in the three months to come. During the calls, analysts for top-of-the-line investment houses ask probing questions of senior management, enhancing their already intimate knowledge of the company’s technical details. Earnings calls are capitalism in action, as information flows from the company to the markets, where it is used to calibrate the value of the company’s stock. Generally, the calls are open to professional analysts and the media, but anybody can dial in.
For people trained in interrogation by the CIA, an earnings call is a bonanza of other indicators about the people speaking on the line. In this instance, the investment analysts were sharp, but BIA’s analysts were about to make them look like amateurs.
The company Hong Liang Lu ran sells broadband, wireless, and handheld Internet equipment and technology around the world. It had generated more than $700 million in revenue that quarter, and although it was still losing money, that performance was good enough to bring it close to profitability. The company thought the results were positive, and the CEO seemed optimistic.
Investment analysts from Bank of America, Smith Barney, Deutsche Bank, and other Wall Street powerhouses were the official participants in UTStarcom’s call. Using their own skills, they were trying to do the same thing that BIA’s interrogators were trying to do. They had just gotten a look at the company’s balance sheet for the second quarter, and were investigating signs of weakness or unexpected strength. They thought the company’s numbers were good, but not great. On August 2 the stock price would drift down from $8.82 per share to close at $8.54. The analysts prepared their best questions to help them figure out where the price would go in coming days. Would UTStarcom emerge as a hot stock in the third quarter? Or should investors sell shares and eat their losses before things got much worse?
Lu’s opening remarks were laced with the complex jargon of the financial and technical worlds. (Only a truly determined analyst—or a spy—can penetrate a sentence like “We believe the new ASICS can take approximately 10 percent out of our cost of handsets and will bring our PAS handset gross margin back into the high teens in the next several quarters.”) He then threw open the session to questions from the Wall Streeters.
One of them, Mike Ounjian, a keen-eyed analyst with Credit Suisse First Boston, jumped in to ask about the guidance the company was giving that day on what its third-quarter (Q3) performance was likely to be. “Just related to the Q3 guidance on the personal communications division,” Ounjian asked, “how much of that business would you estimate being your own designs as opposed to, versus, resale?”
“Mike, this is Hong,” said Lu. “We have, for the rest of the balance of the year; we’re expected to have 0.5 million handsets. And out of that, we are going to probably for the second half of the year, from a run rate wise, we expect to ship a little bit more than 3 million handsets. So I’ll probably say percentage of a number handsets we should be able to get some meaningful numbers. From a dollar amount, are still going to be relatively small because our handsets will be selling less than one half of what normal ASP’s that we are selling.”
“Right. Thank you.”
BIA’s analysts spotted a cluster of telltale indicators in what Lu said. First, Lu’s remarks aren’t always intelligible. And along with his garbled grammar, he offers a series of qualifiers: “we’re expected to,” “probably,” “we should be able to.” The interrogators’ training told them such weasel words meant Lu might be trying to avoid offering a weak third-quarter prediction.
Ounjian then asked about potential problems he’d spotted with revenue recognition as a result of a backlog of products. Revenue recognition is the way companies record income. It can be done either on a cash basis, with companies recording income only when the checks arrive in the mail; or on a more aggressive accrual basis, which means recording the revenue when it is earned, not when the money is in hand. Ounjian wanted to know what was causing the backlog, where in the world it was, and what kinds of delays were involved. All this could affect when the company would be able to record the revenues from the products involved. If the problems were serious, they could affect the company’s financial results in the next quarter, and might cause the stock price to dip.
“Are there any issues related to recognizing revenues on these?” Ounjian asked.
The voice of Michael Sophie, then the company’s interim chief financial officer, came over the phone line: “Yes, with the backlog, the vast majority of the wireless backlog is clearly PAS [an acronym for one of the company’s products, Personal Access System]. I think you saw the announcement at the end of June where we announced on the PAS infrastructure orders in China. And again, it’s just the timing of deployment and achieving final acceptance, we’ve also got some CDMA [an acronym for a type of mobile phone standard] to a lesser extent in the backlog…. But Q3 is clearly a little more handset oriented than we would typically run.”
After analyzing the call, BIA’s employees supplied a twenty-seven-page confidential report to their client, and they singled out Sophie’s response to the question about revenue recognition for particular attention. They noted that Sophie qualified his response and referred back to another announcement from the end of June. BIA called that kind of conversational reference a “detour statement,” and its analysts were convinced that Sophie was trying to minimize the delays. “Mr. Sophie avoids commenting on any issues related to revenue recognition, and his overall behavior indicates that revenue recognition problems cannot be ruled out.” They recommended a presumptive and direct follow-up question for BIA’s client to ask of executives at UTStarcom: “What issues are there related to revenue recognition?”
Overall, BIA’s team rated the second-quarter conference call as a “medium high level of concern”—the same rating they’d given UTStarcom’s call the quarter before. This time, though, the BIA team found more problems, which they listed in a box on the first page of their report: “Lacks Confidence,” “Underlying Concern,” “Avoids Providing Information.”
In the report, BIA went through the call line by line, highlighting possible red flags throughout the transcript. The team offered asides about what they’d noticed and recommended more specific questions they thought might get to the root of the problem. In their conclusion, the BIA team said they’d found that the executives were worried about the timing of the company’s profitability date and the issue of revenue recognition. The report says:
Management’s behavior indicates that they will post poor third quarter results, and it is also highly unlikely they will achieve profitability in the fourth quarter. In addition, during a response addressing backlog problems, management fails to comment on part of the analyst’s question related to revenue recognition problems.
That kind of insight could help an investor make a decision to short a stock. Shorting is an investment maneuver in which firms borrow stock in a company and then sell it, betting that the price will go down and they can buy the stock back for less money before they have to give it back, pocketing the difference in price.
If the price goes down, they make money. If it goes up, they lose. Basically, shorting is a bet against the company. Good short sellers look for unnoticed flaws in a company and exploit them for gains.
Because they’re always trying to discover corporate dirty laundry, short sellers are particularly good clients for BIA—the techniques taught by the CIA are ideal for scrutinizing executives’ forecasts of their company’s prospects. Short sellers are hated in corporate boardrooms across the country. But BIA loves them.
BIA’s client had no way of telling whether the deception analysis report was accurate or not. It was the client’s job to take the report, combine it with other information known about UTStarcom, and make a bet for or against the company.
With the benefit of hindsight, though, we can go back and check the record to find out if BIA made the right call in 2005.
They nailed it.
Over the next month or so after the call of August 2, UTStarcom’s stock price lost about $1 per share, a nice win for any short seller. But on October 6, 2005, the company released its third-quarter results, shocking NASDAQ traders with numbers that were below the guidance executives had offered during the conference call.2 In October, UTStarcom said it expected total revenues of between $620 million and $640 million, compared with its previous target of $660 million to $680 million. The next morning, investors frantically sold their shares: more than 23 million transactions took place on October 7, 2005. A day after the third-quarter results were released, the stock was down roughly another $2, closing at $5.64.3 It had been at $8.54 when the BIA team listened in on the conference call in August and flagged the potential problems with revenue recognition.
And what reason did UTStarcom give for its poor third-quarter performance? Revenue recognition. In a press release on October 6, UTStarcom said, “The Company attributes the revenue shortfall primarily to the delay in recognition of approximately $40 million in revenue.”
What was much worse for the company was its announcement in the same press release that it was under investigation by the Securities and Exchange Commission (SEC), which it said was looking into “certain aspects of the company’s financial disclosures during prior reporting periods.” That was not the primary focus of the conference call.
Apparently, however, the SEC had suspicions of its own, concerning UTStarcom’s past earnings reports. The SEC proceeding was ultimately settled, with Lu paying a $100,000 civil penalty but admitting no wrongdoing.
IT WAS A PowerPoint presentation like many others in corporate America. It was held in 2006 in the bland conference room of SAC Capital Partners—one of the world’s largest and most secretive hedge funds—on Cummings Point Road in Stamford, Connecticut, a stone’s throw from the sailboat-speckled waters of Stamford harbor. Each attendee was given handouts emphasizing key points of the meeting.
But the session at the hedge fund’s offices was like nothing the money managers in the room had ever seen before. The presenters that day included two women with backgrounds in intelligence. Patsy Boycan had spent twenty years with the CIA. She had specialized in polygraph, interviewing, and deception detection during her time at Langley, where she managed the CIA’s crucial security clearance process. Kathleen Miritello had been a senior special operations officer at the CIA; she had more than twenty-five years of interrogation experience in military, law enforcement, and national security environments around the world.4
The women would put on a presentation that day that would dazzle the moneymen. In their intensity, they reminded one money manager of Clarice Starling, the no-nonsense FBI agent played by Jodie Foster in the movie The Silence of the Lambs: “You could tell they knew exactly what they were doing.”
First, they promised that they’d teach the hedge fund managers the CIA’s own foolproof techniques, crafted over decades of clandestine combat, to tell when someone’s lying. Then they said they’d teach the money managers to make money—lots of money—by spotting lies. Of course, it would also cost lots of money to get the training. Sessions with this crew cost as much as $30,000 per day.
By the time of the meeting at SAC in 2006, Boycan and Miritello were no longer working for the CIA. They both had the title “senior expert and instructor” with BIA. Since its founding in 2001, BIA has given its clients access to the same intelligence techniques the U.S. government uses and some of the same employees the government has hired.
BIA takes advantage of a little-known program inside the CIA that allows serving officers to moonlight in the private sector during their off hours and on weekends. A government official familiar with the plan explains it as an employee-retention effort by the CIA. In order to keep officers from decamping for the high-paying private sector, the CIA lets them earn money on the side. The official says that employees have to go through a detailed approval process before they’re allowed to take on outside work. It’s not clear whether companies other than BIA have hired serving CIA officers, and if so which ones, but some inside the CIA express surprise that the practice is allowed. Veterans familiar with the moonlighting say that it may be taking place only at BIA.
It’s more than just a personnel matter. If, as the government official says, the moonlighting program is in place to keep serving officers from jumping to the private sector for higher pay—during a time of war, no less—it’s an indication of the pressure that the rising private intelligence industry is placing on government. There’s no way the federal pay scale can keep pace with the sums available at large corporations, hedge funds, and the like. Some keen observers of the intelligence community say the brain drain to the private sector is chipping away at U.S. national security, as people whose training was financed by the taxpayers quit the government to sell those skills to private businesses.
The presence of so many current and former CIA personnel on the payroll at BIA causes confusion as to whether the intelligence firm is actually an extension of the agency itself. As a result, BIA places a disclaimer in some of its corporate marketing materials to clarify that it is not, in fact, controlled by Langley.
BIA WAS FOUNDED by a small group of CIA veterans, including Phil Houston, one of the CIA’s top interrogators. According to a former CEO of the company, the founding group left the CIA with a feeling of disgust over the Bush administration’s policy on torture after 9/11. The group of CIA veterans (some of whom had been with the CIA for more than 20 years) felt that the administration’s so-called “enhanced interrogation techniques” betrayed everything they stood for as officers—not because torture was morally wrong, they told this former CEO, but because it produced bad intelligence. For a CIA officer who’s proud of his work, there’s nothing worse than an inferior product.
It seemed like a good time to start a private company designed to train law enforcement agencies in the CIA’s state-of-the-art techniques of detecting deception—the science of telling when someone is lying. Using advanced techniques, psychological research, and years of trial and error, Houston had developed a system—in the private sector he called it “tactical behavior assessment” (TBA)—that he maintained was a nearly foolproof way to spot a liar. Unlike polygraph machines, the TBA technique allows examiners to work without hooking up their subject to a series of wires. The subject never knows he’s being scrutinized.
Polygraph machines work by measuring a person’s physical responses, such as heart rate, that indicate stress. Analysts using the machine need to sit with their subject for a long time. They have to establish a person’s physiological baseline, so they begin with a “control” conversation about neutral topics, before they can begin grilling the subject. Conducting an interview and doing a thorough analysis of polygraph results can take hours.
TBA focuses on the verbal and nonverbal cues that people convey when they aren’t telling the truth.5 Psychologists familiar with the method say it works because human beings just aren’t hardwired to lie well. Holding two opposing ideas in your brain at the same time—as you have to do in order to tell a lie—ca
uses a phenomenon they term “cognitive dissonance,” which creates actual physical discomfort. And when people are uncomfortable, they squirm. They fidget ever so slightly, they pick lint off their clothes, they shift their bodily positions. Without even realizing it, they reach for ways to avoid the physical discomfort. They reach for every way to tell the literal truth while still misleading the questioner.
A CIA veteran trained in the TBA technique will begin any session by getting himself into what BIA calls “L squared mode,” which means “look and listen.” Agents look for the physical indicators of lying. They watch for a person shifting anchor points. If the person is leaning forward on one elbow, does he switch to the other one? If the person is seated, does he shift his center of gravity? Interrogators watch for grooming gestures such as adjusting clothes, hair, or eyeglasses. They look to see if the person picks at his fingernails or scratches himself. They watch for the person to clean his surroundings—does he straighten the paper clips on the table, or line up the pens? If he does, he could be lying.
To obtain verbal clues, agents listen for several kinds of statements. They’ll listen for qualifying answers, phrases that begin with words like “honestly,” “frankly,” or “basically.” Those are generally an indicator that the person is trying too hard to convince his audience of what he’s saying, and they’re a red flag for agents trained in TBA. The agents will be listening for detour phrases like “as I said before…” They’ll want to hear if the person invokes religion—“I swear to God”—or attacks the questioner: “How dare you ask me something like that?” These can be unconscious tactics to avoid actually lying to the questioner.
Other red flags: Complaints—“How long is this going to take?” Selective memory—“To the best of my knowledge.” Overly courteous responses—“Yes, sir.” In each case, analysts trained by the CIA see a pattern. And if they spot enough red flags, they know they’ve caught a liar.
