Super Micro Computer‘s (NASDAQ: SMCI) stock is on fire — and not in a good way. Shares of the artificial intelligence (AI) server maker fell off a cliff this week after its accounting firm, Ernst & Young (EY), announced it was resigning. Since the news broke on Tuesday, the stock is down more than 40%.
So what is happening? A whole lot of speculation has been swirling, but let’s get the facts straight and take a look at what we know for sure at this point.
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In 2017, the company delayed some of its financial reporting and underwent an internal audit. The results led to the departure of some key executives, including Supermicro’s CFO at the time, Howard Hideshima.
Then, in 2020, the Securities and Exchange Commission (SEC) charged Supermicro and Hideshima, citing “widespread accounting violations.” The violations included allegedly improperly and prematurely reporting revenue, including it in quarterly reports before it was actually realized, and misusing a special marketing program to avoid recognizing certain unrelated expenses like Christmas gifts. The SEC said the violations gave “investors a distorted view of … [the] company’s financial condition.”
Supermicro and Hideshima neither admitted to nor denied the allegations, but settled with the SEC. The company paid $17.5 million while the CFO paid $260,844.
In August, Hindenburg Research, an “activist” short seller, released a report detailing allegations of continued misconduct. Among the allegations is the charge that Super Micro had rehired several key executives who had left in the wake of the earlier accounting scandal and that a company owned by the CEO’s brother hired the ousted CFO. It also alleges that the company’s dubious accounting practices were still very much present.
Hindenburg alleged the company continued to do business with Russia after the country invaded Ukraine, violating U.S. sanctions. It also alleges that an “oddly circular” relationship exists between Supermicro and several other companies owned by the CEO’s brothers. The list goes on.
While these are serious allegations and they should be taken seriously, keep in mind that Hindenburg has a vested interest in Supermicro’s stock declining. It is how the firm makes money. It compiles a report, takes a short position in the company in question, and then releases that report publicly. These allegations are just that at this point, allegations. They have not been proven and Supermicro continues to deny them.
The day after the report was released, the company once again announced the delay of its required SEC filing.
Last month, it was reported that the Department of Justice (DOJ) is investigating Supermicro, and the news sent shares tumbling. The probe is in its early stage and details are light. It will take time to learn more. What we do know is that the DOJ has begun contacting people with relevant information and was in contact with a former employee turned whistleblower of Supermicro that filed a lawsuit in April.
Note that many companies have DOJ probes ongoing. In and of itself, it is not reason for too much concern, but given the context, I think concern is more than warranted.
Then, just a month later, on Tuesday, Oct. 29, Ernst & Young (EY) announced it was severing its relationship with Supermicro. In a filing with the SEC, EY stated it was resigning due to recent information that meant it would “no longer be able to rely on management’s and the Audit Committee’s representations” and that it wouldn’t be able to do its job “in accordance with applicable law or professional obligations.”
This came after EY had approached company management with concerns about internal controls and accounting practices in July. The special Audit Committee was created after this, but EY was clearly not satisfied with the results.
Abrupt resignations from a company’s registered public accounting firm aren’t usually a good sign, but the full-throated nature of EY’s resignation statement makes this, in my opinion, truly damning. While many of the allegations from the SEC and Hindenburg remain unproven and the company continues to deny them, I would stay far away from this stock right now. It is one thing for a motivated short seller to make incriminating statements about a company. It’s another for an accountant — whose incentives are aligned with its client — to make them.
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Johnny Rice has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
