Shares of Fiat Chrysler Automobiles (NYSE:FCAU) dropped sharply in mid-day trading in New York on Monday after reports emerged that the company is being investigated by the U.S. Department of Justice for fraud.
Details are sketchy, but the implications are big
Citing "people familiar with the matter," Bloomberg reported that federal prosecutors are looking into whether the company violated U.S. securities laws. Bloomberg's sources "declined to specify what conduct is being investigated," the report said. The investigation is said to be in early stages.
Separately, Automotive News reported that investigators from the FBI and the Securities and Exchange Commission "visited Fiat Chrysler Automobiles field staff in their homes and offices this month as part of a coordinated investigation into the automaker's U.S. sales reporting practices." The investigators also visited FCA's U.S. headquarters in Auburn Hills, Michigan, according to the report.
What might this be about? It's not yet clear, but it's likely related to allegations that FCA paid dealers to report unsold vehicles as sold.
In January, FCA was sued by the privately held Napleton Automotive Group, which owns a pair of FCA dealerships in the Chicago area. The suit alleges that FCA asked dealers to falsely report extra sales at the end of each month by listing vehicles still in inventory as having been sold. The dealers would then cancel the sales in FCA's computer system early the next month, before the vehicles' warranties could be activated.
The suit alleges that FCA paid dealers thousands of dollars to make these false reports.
Why this could be bad news for FCA investors
FCA's debt exceeds its available cash. It's struggling to get its European operation moving, to build out its still-small presence in China, to bring a slew of important new models to market, and to boost its profit margins in North America to the strong levels that General Motors (NYSE:GM) and Ford (NYSE:F) have been able to achieve in recent quarters.
In other words, FCA isn't as healthy as most of its major global rivals. But it has had one big thing going for it: Its sales in the U.S. have risen constantly since the economic crisis. June was the 75th month in a row in which FCA posted a year-over-year sales increase in the U.S.
That's a standout achievement, one that has given investors reason to believe that the rest of CEO Sergio Marchionne's aggressive turnaround plan has a chance of working.
The lawsuit called that achievement into question. But it's not unheard-of for dealers to make big allegations when they're angry at automakers, and for those allegations to show up in lawsuits. While investors took note of the case, it wasn't taken too seriously by most. FCA released a statement calling the allegations "baseless" and has since sought to have the case dismissed.
But if it turns out that the Department of Justice is taking it seriously, that's a different story.
How FCA stakeholders should proceed
To be clear, we don't yet know that the Justice Department is investigating the sales-fraud allegations from the lawsuit. It's possible that the investigation will turn out to be about something else entirely. It's also possible that prosecutors will decide that there's not enough evidence to file charges.
But it's also possible that this will turn into a big deal that casts doubt on a key part of the investment case for FCA -- not to mention some members of the company's management team. Watch this one closely.
Editor's note: A previous version of this article mistakenly referred to Napleton Automotive Group as "Napoleon Automotive Group." The Fool regrets the error.