Shop cop 
 | Former police detective Tom Yake investigates America's biggest retailers for corporate governance misdeeds
Tom Yake, founder of Yake & Associates Inc., a corporate governance research firm in Kennebunk, learned some of the best lessons about how to expose crooked corporations by investigating mobsters and drug dealers. “I learned the adage, ‘Just follow the money,’” he says of his days as a detective working the narcotics and organized crime beat in Indianapolis, Ind. â&Copy;
As a cop, he’d spend his days poring over documents, trying to figure out who actually owned massage parlors or strip joints. “It got to be interesting how patterns developed and weaved together,” he says. “It was a tapestry that you had to figure out how to read.” â&Copy;
Since 1988, Yake has used those same skills to research big retailers, looking for signs of corporate mismanagement like inflated inventories or questionable expansion plans. Yake, 58, knows the corporate sector well, having worked off and on for three decades at national retailers like Service Merchandise. â&Copy;
His clients are law firms, the Internal Revenue Service and the big-time money management firms that invest in national retailers — often to the tune of hundreds of millions or even billions of dollars. And because of those big positions, fund managers want to know their money isn’t being threatened by what’s happening behind closed boardroom doors. Enter Yake & Associates to research a retailer’s performance by walking the aisles looking for inventory issues or following the money by poring through old accounting ledgers.â&Copy;
Mainebiz recently sat down with Yake to discuss how he investigates a suspect retailer, how to spot a “trigger event,” and whether reforms like the 2002 Sarbanes-Oxley Act have changed companies’ attitudes about corporate governance. The following is an edited transcript. â&Copy;
Mainebiz: Your clients are money managers?â&Copy;
Tom Yake: Our clients are money managers that handle retirement funds from the pensions. Probably 70% of the time the client has a pick, and 30% of the time I’ll call retirement funds and tell them, “this is what we’re observing, these are the practices we’re observing that run contrary to your best interests and you have a major position in this company.”â&Copy;
How big are the clients you’re working with?â&Copy;
On average, around $50 billion [in assets]. â&Copy;
Can you tell me the names of any of your clients? â&Copy;
I can’t. We have restrictions and embargoes. I can’t even release my findings for a predetermined amount of time. And some times, the embargoes are put into place to let a fund manager make his trade — digest the information and determine what his or her investment strategy is going to be and then make their trade. And typically, that’s two or three weeks. â&Copy;
But with the research I provide, it’s more customarily two years. I can’t republish a report or even use it as an example in another form for two years. And in the case of proxy fights, I can’t release those reports ever. â&Copy;
When you start researching a retailer, what’s your process?â&Copy;
Normally, I’ll focus on the inventory. We’ll look at a retail company and its organizational structure from the time inventory is purchased in the merchandising department to the time it leaves the store at the point of sale. And there are a lot of different points in between: Inventory has to be purchased, it has to be accounted for in accounting, it has to be distributed through the supply chain, it has to be replenished by the IT department. We look at the integrity within each of those departments. â&Copy;
One of the biggest findings we have nowadays is the lack of integrity of the system. Nobody audits the system. And one of the selling points I use is that no system fails until it’s audited, or no control fails until it’s audited. So what our examination does is essentially test or audit those practices by talking to people and looking at real-life examples at the store level. And then when we bump that up with the financials, you can usually validate your findings. â&Copy;
Can you give me an example?â&Copy;
One of the stores we were working on recently in a proxy fight, when we walked in the stores after Christmas, the shelves were still bulging from inventory. It looked like the day after Thanksgiving when retailers want to have their shelves full — the old adage was “stack ‘em high to the sky.” And after Christmas, those shelves should be depleted. That’s why inventory was taken — or it used to be taken — right after the first of the year, because your inventory was at its lowest point and it was the easiest to count. You certainly didn’t want to see stores bulging with inventory. And if the stores are bulging with inventory, chances are the distribution centers are, too. That tells me that their systems aren’t working right, that they don’t know what to replenish where, and it also tells me that they’re buying the wrong stuff. When you see that type of condition, you normally see working capital being eaten up on the financials. Their cash starts to drain. They’re overbuying.â&Copy;
So retailing is an inventory game.â&Copy;
In retailing, the inventory is almost always the largest asset on the balance sheet. We were the first people who called out Rite-Aid as a problematic company. We had them on our watch list eight years before all the bad news hit. â&Copy;
What happened with Rite-Aid?â&Copy;
It seemed like Rite-Aid was in the real estate business, not the retail business. It was in 2000 or 2001. When they did the acquisition of Brooks Drugs up here, you could see them close all the Brooks stores — even though they were in fairly good condition — and build brand new ones. Guess what? Management had what became known as synthetic leases. In those days, they didn’t have to disclose that management actually owned the building and they were paying themselves rental income from that real estate. Their focus wasn’t on the retail business; they were in the real estate business to line their own pockets. â&Copy;
What keyed you in on that years before the rest of the market saw it?â&Copy;
The fact that they were closing perfectly good stores and building brand new, shiny ones a mile away. One thing that struck me is that they were always within two to three miles of the original store. It just didn’t pass the smell test. â&Copy;
As the first to notice something like that, did you feel like a contrarian?
The first report I ever did was on [corporate governance issues at] Home Depot, and people thought I was smoking something funny up here in Maine. The first fund that I did that report for waited three years for every prediction to come true and today they’re probably my largest client. Wall Street is the most skeptical crowd that I’ve ever tried to sell services or products to. â&Copy;
Is it a sheep mentality on Wall Street? Hard to diverge from the pack?â&Copy;
It’s very difficult to diverge from the pack. I think I did the report in 1996 and 1997, and Wall Street made a boatload of money [on Home Depot] the next six years. But when does a fund manager determine they need to pull the plug and get out? And that’s where we make our money. We tell them, “Here’s what we’ve identified. We think we can predict the bad news, but we have to continuously monitor that.” We call it recurring due diligence, where you just stay on top of it and look for trigger events. There are trigger events that always precede the bad news. Those trigger events may be that new management comes in, and they may be a change in inventory practices, the way they account for inventory. They could be losing the chief merchant — the senior VP of merchandising — that’s a huge trigger event.â&Copy;
Who helps you identify those trigger events?â&Copy;
I have four analysts. I never believed I was smart enough to know everything about retailing. My expertise was really in store operations and business controls. But I didn’t know that much about merchandising, and I needed to go out and find who I thought was the best person who knew best practices and could identify the flawed practices. And who could articulate in layman’s terms why the terms or the indicators they were seeing were bad news, and not just talking in retail mumbo jumbo that even lost me. So I have experts in the key departments, and those are merchandising, finance, IT and supply chain. I take store operations.â&Copy;
How did Yake & Associates get its start?â&Copy;
I started this as an executive search business. The reason I left retailing at 36 is I thought businesses existed to be bought, sold, bankrupted and reorganized. I wasn’t going to stick around for the show — I didn’t want to wake up at 50 and find that the company I was working for was going bankrupt. There was that skepticism and that frustration — I wanted to try and solve the problem. â&Copy;
The first problem was the human resources that were being recruited. The standard cadre of people that I saw going into retail companies were the recycled and the retreaded executives who destroyed one company and went on to work their magic at another. These guys would get tremendous golden parachutes and tremendous packages to go right back in and destroy another business. I thought we could offer a difference, and started off in executive search. â&Copy;
And that field just pays so much that those checks hit your checkbook like a freight train. That gave me the working capital to go into consulting and we started consulting with the failing retailers. There were a bunch of bankruptcies that hit around the time I started business in 1988. And the first one we got was Revco Drug Stores, which was huge. I want to say they had 6,000 stores — they started closing them and spinning them off so fast it was hard to keep track of them. I knew from working in retailing that there was a correlation between abusive practices and failures. â&Copy;
Have attitudes towards corporate governance changed since the Enron debacle and the subsequent reforms of the Sarbanes-Oxley Act? â&Copy;
Not enough. I think Sarbanes was kind of a knee-jerk reaction to Enron. The laws already existed on the books to punish and prosecute bad corporate behavior. But they were so embarrassed — it wasn’t just Enron. WorldCom hit, Rite-Aid hit the same year. But Enron was so flagrant and came on the heels of so many other business failures. I’d get calls from the Wall Street Journal and other financial magazines asking my opinions, and my standard reply was, “Well, I don’t know why this should surprise you. This has been going on in the retail industry for the last 20 years.” There were over 200 major retail business failures between 1988 and when Enron hit, in 01 or 02.â&Copy;
What was going on in retail? Poor management? Shady dealings?â&Copy;
The shady dealings, the behind the scenes — the big word today is transparency. They lacked so much transparency. Well, if [Enron] wasn’t such a big failure, if it hadn’t rocked the financial community so much, Sarbanes would have never been passed. And then what disturbs me more than probably anything else is how many of these so-called experts on corporate governance have come out of academia and they’ve never handled an integrity matter in the workplace, yet they’re pontificating on all the things that are needed to enhance governance. I don’t know how many definitions I’ve seen defining and redefining corporate governance since Enron hit. â&Copy;
And I got into this with CalPERS [The California Public Employees’ Retirement System], after Enron, that they were after some panacea, some quick fix to gauge corporate governance. You can’t separate integrity from governance. If you look at behavior, corporate behavior cannot be separated from corporate governance. They have to work together. You can put up all this academic lingo in the world and continue to try to be the next big brainchild in corporate governance definitions and pontification, but it all boils down to — does the company and does the board and does the management have integrity or don’t they? Do they enforce business integrity practices or do they treat it with selective neglect?â&Copy;
Taylor Smith, Mainebiz editor, can be reached at tsmith@mainebiz.biz.
Mainebiz web partners
Most Recent
Most Recent
Comments