Double Standard For Corporate Blowups

Includes: AOBI, FUELQ
by: Marc Gerstein

It has long been a bedrock principle of our legal system that similarly situated parties ought to be treated similarly. In many walks of life, failure to do so amounts to actionable discrimination and this is why the principle tends to be discussed mainly in the context of civil rights. But it can be important in the investment arena as well as we can see in recent fortunes of those who've been holding shares of SMF Energy (FUEL) and American Oriental Bioengineering (AOB).

We have, here, two corporate blowups, both, coincidentally, having occurred on the same day. In one instance, the stock continues to trade thus having given aggrieved shareholders many opportunities to get out before the shares plunged to the bottom of busted-company canyon. In another, trading was immediately suspended, potentially forcing all shareholders to go directly from the top of the cliff down to the bottom, with no opportunity to grab onto an in-between ledge.

The stock that still trades is FUEL. It would be easy to understand if you haven't been following the mess at that Florida-based provider of mobile gasoline refueling services mainly to trucking fleets. As recently as the early part of this year, things were going great and management was racing to boost its recently-initiated dividend in response to rapidly improving fundamentals, the latest such occurrence having taken place on 1/15/12. But long before most investors had a chance to discover this sub-micro-cap, one that came to my attention through my newsletter covering stocks priced below $3, the story vaporized.

On 3/16/12, barely two months after a 15% dividend boost, management suspended the payout, convened a board committee to re-examine a business model that had apparently imploded, and waved goodbye to an outside director who came aboard on 2/17/12 but apparently decided this was a hornet's nest through which he didn't care to rummage (I'm guessing here; the flow of objective facts has been remarkable in its skimpiness). Then, on 4/16/12, SMF filed for bankruptcy. Easy come, easy go.

Will there be legal investigations and lawsuits? Who knows? It wouldn't shock me given the way so many corporate law firms today seem to need to find ways to keep occupied. After all, I've had three newsletter stocks that jumped recently in response to buyout offers, although the deal announcements were hard to find in the news sections of web sites given the way they were buried under so many other announcements of law firms launching their own investigations into the fairness of the (well-above-market) buyout prices and potential breaches of fiduciary duty on the parts of managers: see, e.g. Great Wolf Resorts (WOLF), where a competing bid has emerged, Southern Community Financial (SCMF), and most recently, Dreams Inc. (DRJ).

Where are the law-firm announcements regarding SMF? Don't get me wrong: I have no idea if anything illegal occurred here. Corporate executives are under no legal obligation to make correct or even intelligent decisions. They are only required to act in good faith. In other words, decisions can be dumb, as long that the dumbness is honest. Imagine how crowded court dockets would be if it were otherwise. (At this point, though, the existence of a bankruptcy would make any litigation much more complex.)

But if a law firm is going to investigate whether management acted wrongfully in seeking to deliver to shareholders a quick profit, one would think a loss-producing corporate implosion would prompted at least a peek before the bankruptcy filing occurred.

But what should I make of the fact that FUEL has been allowed to continue trading since 3/16/12? Personally, I benefited from the way things worked out. I dumped my shares that day at about $1.47, which is a heck of a lot higher than where they're trading now: the quote as I write this is $0.25. Many others who sold when I did or shortly thereafter are probably feeling pretty good, all things considered (it would have been best had we not owned FUEL at all, but bad things happen and when they do, we at least appreciate opportunities to get out with less-than-maximum damage).

The negative flip side is of that is that the regulatory setup paved the way for others to buy into a ticking time bomb. Should we just say caveat emptor and leave it at that? Let's postpone judgment until we consider the other 3/16/12 disaster.

At the same time I was jettisoning FUEL, another situation about which I'd written, American Oriental Bioengineering, also imploded. This company is a major producer of often-herb-based prescriptions and over-the-counter medications in China. (Did you even have one of those days you wished you stayed in bed? For me, 3/16/12 qualifies in a big way.)

OK. I said it, the "C" word. Today, many in the investment community almost reflexively sneer when they see the word "China" and almost assume the second letter, "h," stands for hoax. However this business is quite real. In fact, my just-migrated-from-China in-laws confirmed that they recognized and regularly used many of the products the company lists, and that these are, indeed, popular major-league products. One such offering is in my home right now.

Having a genuine business doesn't necessarily spell paradise for a company: raw material costs and price controls have been troublesome here. But that's an issue I evaluated in a typical analytic content and baggage I was and often am willing to accept (I am willing to be patient through transitory problems like those.) But then, on 3/16/12, that stock ceased trading as the company announced it would be late in filing its 10-K due to "certain inconsistencies" discovered by the firm's auditors. The last price on 3/15/12 was $1.52 and my guess is that when AOB resumes trading, whenever that happens, it will open near where FUEL is today.

Viewed in terms of before-and-after prices, FUEL and AOB will likely turn out much the same. The problem is the in-between periods. FUEL had one during which market participants were free to make sound or unsound decisions to sell or buy. That's the normal state of affairs in the stock market. Caveat emptor! But with AOB, there were no such opportunities. Bottom fishers who think AOB will turn out fine have no opportunity to buy. Others who want out have no opportunity to exit, except, probably, at a future bottom-of-the-canyon price.

Is it right that FUEL has been allowed to continue trading since 3/16/12? I don't know. Is it right that trading in AOB has been suspended since 3/16/12? I don't know? Is it right that we're seeing different outcomes for these two situations? Heck no! And I feel this way whether the differing outcomes result from a specific regulation or decision by a person who administers regulation. In my opinion, either the people got it wrong, or the regulatory scheme is wrong.

Now, to some, it may appear that FUEL and AOB are not similarly situated. One comes about through a need to review a business model that went bad (so I suppose since, as noted, the facts are skimpy); the other involves a need to investigate the accuracy of financial statements.

Lawyers, law professors and judges have a phrase for this: a "distinction without a difference." In deciding whether two situations are similar in a legal sense, we don't focus on surface details but instead look at the main elements, the essences that make each situation what it is. While the details of FUEL and AOB are quite different, the main elements are the same: Shareholders of each are in the dark right now as to company fundamentals. With AOB, they're in the dark because the 10-K hasn't yet been filed and there is a possibility that historic statements may be amended. With FUEL, financials had been filed (at least as of 3/16/12) but there's no way any shareholder could take any of them seriously considering the 180-degree switch in management rhetoric from 1/15/12. Would you bet your I.R.A. on the numbers in the most recent FUEL filings?

So the essences of both situations are identical. It's been impossible since 3/16/12 to analyze FUEL. It's been impossible since 3/16/12 to analyze AOB. Yet FUEL shares continue to trade even today while trading in AOB has been suspended since 3/16/12.

I am not now expressing an opinion as to whether the shares of these companies should have continued trading after 3/16/12. (For the record, I eagerly bailed out on FUEL, but am now stuck in AOB.) I am, however, suggesting that the outcome should have been the same for both (and would still say so even if I was still stuck in FUEL).

And by the way, I assign no relevance whatsoever to the fact that AOB is a Chinese micro-cap. Many readers may disagree. You don't have to tell me all about the other situations that went bad. I follow the area closely and am quite familiar what goes on. Let's take a worst-case scenario and assume AOB looks like a case of fraud. (I'm not saying it is. I don't know at this juncture. It's a hypothetical assumption for illustrative purposes.) Can we say that FUEL is so much more legit? Again, at this juncture, we don't know.

Given the current shortage of facts regarding both situations, I'm actually more afraid of FUEL, the U.S. company. I know AOB is a legitimate business; the problems, if any (and which may be small or big), relate to tallying the financial performance. With FUEL, I cannot now even begin to think about the financials because to do that, I need, as a starting point, at least a clue as to what the heck the business is and since the 3/16/12 announcement, that has been absent. (It bears repeating that as recently as 1/15/12, the company raised its dividend citing confidence on the future and that a few weeks later, a new outside director happily came aboard but that on 3/16, the business model appears to be so screwed up a board committee, not management, has to review it, the new director bolted, and a bankruptcy filing occurred barely a month later.) Imagine SMF were headquartered in Harbin, China. How nervous would you be? Wouldn't you be even more scared there than with AOB?

Some readers will agree with me that both situations ought to be treated the same: Either both should trade or trading in both should be halted. Others will disagree. To those inclined to disagree, I respectfully urge you to avoid getting caught up in the China hype. I encourage you to form your opinion as if SMF were a Chinese firm whose stock came public in the U.S. via reverse merger.

Disclosure: I am long AOB.

Additional disclosure: I'm long AOB because trading is suspended. I assume i'll get out when able.