Why the Feds Are Investigating Fiat Chrysler Automobiles' Sales Reports

There's no doubt that FCA has seen supercharged sales growth in recent years. But federal investigators are asking whether FCA might have overstated that growth. Image source: Fiat Chrysler Automobiles.

Fiat Chrysler Automobiles (FCAU) is facing investigations into its sales reporting by the Securities and Exchange Commission (SEC) and the U.S. Department of Justice, the company confirmed late on Monday. 

The background: Why FCA is being investigated

A lawsuit against FCA filed in January by the privately held Napleton Auto Group, a Chicago-area dealer group that owns two FCA dealerships, alleges that the company asked dealers to falsely report extra sales at the end of each month. 

According to documents filed in the case, dealers would mark vehicles as "sold" in FCA's reporting system right before the end of the month, then cancel the sales a few days later before the vehicles' warranties were activated. The suit alleges that FCA offered dealers thousands of dollars to make these false reports. 

It appears that federal officials found the dealer's allegations credible enough to begin investigations. The investigations were first reported by Bloomberg around midday (Eastern time) on Monday. 

What FCA said about the investigations

Late on Monday, FCA released this terse statement:

In response to press reports today, FCA confirms that it is cooperating with an SEC investigation into the reporting of vehicle unit sales to end customers in the U.S. In its annual and quarterly financial statements, FCA records revenues based on shipments to dealers and customers and not on reported vehicle unit sales to end customers.

Inquiries into similar issues were recently made by the U.S. Department of Justice. FCA will cooperate fully with these investigations.

What FCA's statement tells us about its likely defense 

Note that FCA's statement is careful to distinguish between "vehicle unit sales to end customers" and "shipments to dealers and customers." 

It sounds like hair-splitting, but here's why it's significant.

The allegation is that FCA manipulated its monthly sales reports, which track "vehicle unit sales to end customers" -- in other words, vehicles that have been sold by dealers. FCA is saying that in its financial reports, the ones that matter most to the SEC, it tracks sales differently. FCA, like other automakers, records revenue based on how many vehicles it has shipped to dealers (and to end customers, for the few vehicles it sells directly). 

That makes sense because it's the dealers that pay FCA for its vehicles. The dealers are separate businesses that then resell the vehicles to customers. Tracking those sales to customers helps show demand for FCA's products, but it's the shipments to dealers that affect revenue (and thus profits).

The distinction matters because the SEC's concern is probably that FCA may have misled investors about its U.S. sales success. It looks like part of FCA's defense will be that even if its monthly sales numbers were inflated, the revenue it reported in its financial statements wasn't affected by the manipulation of the monthly numbers.

It's also worth noting that FCA began adding this disclosure to its U.S. monthly sales reports starting with the report for March 2016:

Method of Determining Monthly Sales. FCA US's reported vehicle sales represent sales of its vehicles to retail and fleet customers as well as limited deliveries of vehicles to its officers, directors, employees and retirees. Sales from dealers to customers are reported to FCA US by dealers as sales are made on an ongoing basis through a new vehicle delivery reporting system which then compiles the reported data as of the end of each month. Sales through dealers do not necessarily correspond to reported revenues which are based on the sale and delivery of vehicles to the dealers. In certain limited circumstances where sales are made directly by FCA US, such sales are reported through its management reporting system.

Add it up and it sounds to me like FCA is preparing for the possibility that these allegations will turn out to be true. If they are, I think there's still a case to be made that FCA misled its investors. 

Why would FCA want to pad its monthly sales totals? 

FCA isn't a healthy company, and investors know it. It's dealing with big problems on many different fronts, from a huge debt load, to shortages of its most popular products, to crucial product development programs that are far behind schedule. 

CEO Sergio Marchionne has a plan to deal with all of that. Aspects of the plan may seem far-fetched and improbable, but one factor arguing that they're not too improbable has been FCA's long streak of sales growth in its most profitable market, the United States: June was the 75th month in a row in which FCA had reported a year-over-year sales increase in the U.S. 

There have been several months during that streak in which FCA seemed to eke out an improbable small year-over-year sales gain while most of its rivals posted year-over-year declines (most recently, in May of this year.) It's plausible that FCA's sales officials may have resorted to shenanigans to keep that streak of sales gains going in tough months.

What happens to FCA's shares if the allegations are proven true?

The fudged sales probably don't add up to giant numbers that would call FCA's overall sales story into serious question. And if it turns out that the allegations are true, FCA can fall back on the defense that it didn't inflate its financial reports (assuming it didn't). 

But if the allegations are proven, FCA will probably face fines in the millions of dollars (not billions). Some of its individual executives could also face penalties, including (perhaps) criminal fraud charges. 

For investors hanging on to FCA shares in hopes that Marchionne will be able to pull off a dramatic turnaround, it won't quite be the end of the world if these allegations are proven. Like I said, the overall story -- that FCA has dramatically increased its U.S. sales over the last several years by making genuine improvements to its products -- is undoubtedly true even if the company exaggerated its monthly sales gains. 

But it would punch a hole in FCA's credibility that would raise doubts about the company's ability to execute its overall plan, and it could take key executives out of the picture. That would hurt the stock.