FOOL ON THE HILL
The Trouble With ACLN

Trading in ACLN stock was halted yesterday by the SEC to give the company time to answer some questions about discrepancies in its financials. Most of these discrepancies were well known to investors, as the SEC had been looking at the car-shipping company for several months. People who look for inefficiencies in the marketplace sometimes find that the market knew what it was doing all along.

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By Bill Mann (TMF Otter)
March 19, 2002

I've been on record in the past saying that I liked companies in ugly businesses. One of those that I liked, and bought, was Cypriot car-shipping company ACLN (NYSE: ASW). Well, right now this one's a bit uglier than I had envisioned. Yesterday the Securities and Exchange Commission ordered the New York Stock Exchange to halt trading in ACLN's stock until April 1, 2002 to give the company time to answer some questions that came up during an SEC investigation. Later in the day, the NYSE sought to delist the stock.

This is a company that I've written about a few times in the past, most recently in December, specifically to take Herb Greenberg to task for using a great deal of innuendo in his columns about ACLN. I also used those columns to squeeze a round or two off at ACLN's managers for being stupid enough to get themselves into a position where their company would be a Greenberg target in the first place.

Don't shoot the messenger
Herb was right to sniff where he saw smoke. That's what you're supposed to do as an investor. If you cannot forcefully argue the negative case (or conversely, the positive case for a company you hold short) for any company you own, you should NOT buy it. I know it is tremendously easy for people to look at a company and see nothing but sunshine ahead, but here's a hint: It NEVER works that way. It is your job to know as best you can what the risks are.

This, unfortunately, still won't necessarily make you right. As outside investors, we simply have to trust that certain things management is saying are accurate.  I have said in the past that there is no specific need for investors to take the added risk of holding international equities. The risk is that you are dealing with laws, cultures, reporting standards, currencies, and disclosure policies that are different than those in the U.S. In many cases these are worse, but in ALL cases they are different. As we've seen in the past few months, it may be foolhardy to simply trust even the U.S. regulatory body to dispose of its duties, to catch the bad guys, and to be an effective deterrent. Putting the same faith in the regulatory regimes in, say, Indonesia, Spain, or Cyprus is doubly so.

Let this remain lesson No. 1: It is by no means required for you to invest in international equities, especially if your home market is the United States.

ACLN should stand as the embodiment of what can happen to the shareholders of a company that doesn't seem to have a clue about the necessities involved in shareholder disclosure. I knew this in advance of my purchase of ACLN, and I bought it, anyway. After the first revelations of problems at ACLN, I kept coming back to the conclusion that the company was guilty of shoddy bookkeeping, but I was unable to conclude that ACLN was an outright fraud. This leads me to believe that the company's stock represents a true binary situation: It is either worth nothing, or it's worth something north of $40.

That the company stood at $9 said that other shareholders had come to a similar conclusion. Why in the world else would a company that reported 74% income growth in the last year and significant free cash flow be priced at a P/E of 1, an ROE of 47%, and a 60% tangible book value? Healthy skepticism, that's why. A significant number of people believed management was lying about its results, its assets, and its business. I didn't. I fully accept the consequences if I am wrong.

So, after two months of an investigation, the SEC has put a two-week halt on ACLN stock in order to get the following questions answered:

  • Whether or not ACLN actually sold as many cars as they say they did;

  • Whether the company was right in listing the boat "Sea Atef" as an asset;

  • What the basis is for ACLN's February announcement that it acquired majority stakes in five companies;

  • The relationship and business transactions between ACLN and MFT, a company wholly owned by ACLN's CEO;

  • The source and use of funds declared by ACLN as assets in its September earnings report;

  • Why it was never disclosed that the ACLN CEO was wanted in Tunisia on charges of misappropriating funds from another company.

With the exception of the last item -- a surprise to most everyone who follows this company -- I was personally aware of each of these as a question, and thought (think) I had reasonable answers. ACLN is a virtual company with 12 direct employees backed by an enormous web of agents and assignees.  I doubt that any one of these employees had any idea of the level of scrutiny and reporting that would be required in conjunction with listing in the United States, much less on the NYSE.

So, what in the world was I thinking when I held on to a soon-to-be-delisted stock in a Cypriot company that was engaged in the business of exporting used cars to Africa?

From the outset, I had full expectations that the SEC would find something wrong with ACLN's books. In fact, it was a certainty. Why? This is a company that operates in some nasty countries, in particular Nigeria Cameroon, and Angola. It would be utterly naive to assume that ACLN got its position in these countries without some payola to local officials, something that the U.S. frowns upon. Anyone who has ever worked in almost any Third World country will tell you the same thing: Nothing gets done without the wheels being greased.

Heck, there are parts of Europe where this is also the case, and most European jurisdictions have a completely different viewpoint of bribery being a necessary evil to get things done in developing countries. I also figured that, as a 12-person company that lacked operating experience in the U.S., ACLN would have neither the bandwidth nor the ability to manage its reporting requirements to the SEC very well. This is the reason I argued that the company had made a horrible mistake in having an inexperienced 28-year-old as CFO. It is possible for companies with tiny employee bases to have fairly wide operations. But you must have someone who watches the filings and knows the pitfalls, and ACLN's CFO wasn't up to the job.

Now it surfaces that the Chairman of ACLN has a 10-year-old warrant against him in Tunisia for corporate mismanagement. Again, this is no big surprise as far as I'm concerned. While I lack specific knowledge of Tunisia's operating environment, in many countries in the region such a charge would generally mean only one thing: You got a government official mad at you. Business ethics laws simply do not have the same sanctity in many places that they do in the U.S. Which is why no one really cares that there are only one or two cabs in all of Cairo that charge the legally mandated fares, and that a few rupees handed over to an Indian customs official will help get a shipment found and cleared a heck of a lot faster than if you try to play exactly by the rules. Call it flower money, expedite fees, baksheesh, chai, dash, grease, whatever -- the biggest danger you have once you start paying it is that someone will feel slighted because you failed to pay him his "fair share."

Is this what happened with ACLN? We have no way of knowing right now. The company is a real business. Most likely it has to do some fairly unsavory things to retain its position, and it has kept some sloppy books. I would imagine this is the case with dozens of foreign companies that trade in the U.S., but for now it is ACLN that has to answer some serious questions from the SEC.

ACLN, if it wants to have any credibility at all, had better address these questions in ruthless fashion. Further, the company must put into place a corporate governance team that treats these issues with the thoroughness they deserve. Shareholders should never have to go to sleep wondering if the managements to whom they have entrusted their money are snookering them.