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The Fraud Discovery Instititute (FDI) led by my close friend, convicted felon,turned fraud fighter, Barry Minkow, has issued a new report (.pdf) entitled, "Ten Red Flags for Fraud at Speedway Motorsports, Inc. (NYSE:TRK)." Minkow started a new website called SpeedScamMotorSports.com and posted a You Tube Video to explain details of his investigative report.

According to FDI's report, "There are plenty of signs pointing to fraud and mismanagement at this company [Speedway Motorsports]." The report goes on to list ten red flags (download pdf file here). FDI's latest report focuses on inconsistent and contradictory disclosures by management and the company. It also carefully scrutinizes related party transactions and certain stock pledges that I will describe in more detail below.

Minkow has publicly disclosed that he owns put options in Speedway Motorsports and almost always holds a short position in companies that he investigates.

Minkow's latest report, follows up on a background check by FDI about two weeks ago that exposed Speedway Motorsports President and Chief Operating Officer Marcus G. Smith lying about his academic credentials in an SEC filing which claimed that he graduated from the University of North Carolina at Chapel Hill. Such a false claim about Smith's academic background also violated his company's Code of Business Conduct and Ethics (.pdf).

O. Bruton Smith, who is the Chairman and CEO of Speedway and his Marcus Smith's father, controls about 67.5% of the company's stock. How could he not know that his son did not graduate from college? Did Marcus Smith lie to his father, too?

With such open questions about the two top officers at Speedway Motorsports who control most of the stock, I can understand why Minkow decided to further investigate Speedway's financial disclosures, especially related party transactions.

In any company, the centrality of control by one or a few closely related persons makes it relatively easy for management to circumvent internal controls and commit fraud. In both Minkow's fraud at ZZZZ Best and my fraud at Crazy Eddie, too much power at the top of our corporate hierarchies made it relatively easy for us to commit our crimes. Such internal control issues are recognized as important auditor considerations for possible fraud under Statement of Auditing Standards No. 99 (.pdf).

Barry Minkow believes that if you lie about your educational background, you are capable of lying about anything else, too. In this case, apparently Minkow believes that where there is smoke in the form of phony academic credentials, there is fire in the form of other possible frauds, too.

Pledged Shares Raise Serious Concerns

The most interesting aspect of FDI's report for me, relates to O. Bruton Smith's pledged stock shares that potentially could cause Speedway's stock to plunge:

According to the most recent proxy, O. Bruton Smith and Sonic Financial (a company owned primarily by Mr. Smith) collectively own more than 29 million shares (67.5%) of the company's outstanding common stock. Over 10.5 million of those shares have been pledged as collateral for loans. About half of the pledged shares are for loans made to Sonic Automotive (another company of which Smith is the majority owner), and the other half are pledged on debt for which no information is provided.

Sonic Automotive is clearly in serious financial trouble, and its auditors have advised that the 2008 audited financial statements might need a "going concern" qualification. The company is not likely to survive the next year. Sonic Automotive has apparently violated lending covenants, which would put this pledged stock in jeopardy.

Note: Bold print, italics, and link added by me.

Sonic Automotive's (NYSE:SAH) most recent SEC filing corroborates FDI's report:

The management of Sonic Automotive, Inc. (the “Company”) has determined that the Company is unable to file within the prescribed time period, without unreasonable effort and expense, its Form 10-K Annual Report for the period ended December 31, 2008 because management needs additional time to finalize and analyze its financial statements. While the Company was in compliance with its financial covenants under its syndicated Credit Agreement dated February 17, 2006, as amended (the “Credit Agreement”) as of December 31, 2008, management is assessing whether the Company will be in compliance with its covenants through December 31, 2009. The Company’s independent registered public accountant recently advised the Company that it would have to consider including a “going concern” modification in its audit report for the Company’s 2008 financial statements because of possible noncompliance with a financial covenant of the Credit Agreement as of completion of the quarter ending June 30, 2009. The issuance of a “going concern” modification by the Company’s independent registered public accountant would, by itself, violate a separate covenant of the Credit Agreement. The Company has commenced discussions with the Administrative Agent of the Credit Agreement in order to obtain (A) an amendment of the Credit Agreement to modify such financial covenant, and/or (B) a waiver of any instances of noncompliance, including the covenant implicated by a “going concern” modification in the audit report for the Company’s 2008 financial statements.

Because the assessment of the Company’s financial position and liquidity depends to a significant degree upon its ability to obtain the amendment and/or waiver, which the Company cannot obtain by the close of business on March 16, 2009, the Company is unable to complete its Form 10-K in a timely manner. The Company plans to file its Form 10-K by March 31, 2009, as prescribed in Rule 12b-25.

The Company cannot be assured that an amendment and/or waiver will be obtained from the lenders under the Credit Agreement on acceptable terms, on a timely basis, or at all, or that any amendment or waiver obtained will avoid the Company receiving a “going concern” modification in the audit report of the Company’s independent registered public accountants. The amendment and/or waiver could contain additional terms which, among other things, could increase the Company’s interest expense, result in increased fees, and limit the Company’s ability to fund our operations or pay outstanding indebtedness, including but not limited to payment of the Company’s 5.25% Convertible Senior Subordinated Notes which mature on May 7, 2009. If the amendment and/or waiver are not obtained, the lenders could require the Company to repay all amounts outstanding under the credit facilities, which could also cause cross defaults of other debt and lease facilities, all of which would have a material adverse effect on the business, financial condition, liquidity and operations of the Company and raise substantial doubt about the Company’s ability to continue as a going concern.

Note: Bold print and italics added by me.

Therefore, about 5 million shares of Speedway Motorsports 43.128 million shares or about 11.6% of the outstanding stock are pledged as collateral for certain loans made by Sonic Automotive. However, Sonic Automotive may be out of business within a year.

A Sonic Automotive bankruptcy can potentially cause Speedway's stock to plunge, if lenders take possession of Speedway Motorsports stock collateral and sell such stock in the open market to recover losses.

I could not find any risk factor in Speedway Motorsports recent 10-K relating to such stock pledges. The absence of such a risk factor disclosure is one red flag my friend Barry missed.

Disclosure: I do not own any position in any of the companies named in this blog post, long or short.

Barry Minkow and I are close friends. We usually alternate who picks up the tab for meals. However, he paid for the last two meals. Therefore, the next two meals are on me.

Source: Barry Minkow on Speedway Motorsports: Troubling Disclosures, Serious Concerns