Why Super Micro's legal woes could be deeper than they appear

By Therese Poletti

Super Micro Computer Inc.'s legal issues may have gotten more complicated, adding another cloud of uncertainty over the once-hot server-maker's stock.

On Thursday, the Wall Street Journal reported that the Justice Department is probing Super Micro (SMCI) and that the investigation is at an early stage, citing people familiar with the matter. The Journal reported that the probe follows a critical report on the company by activist short-seller firm Hindenburg Research. Super Micro declined to comment to MarketWatch.

"It is impossible to speculate on what the DOJ is looking at. It could be related to the Hindenburg allegations or not. It could be potentially criminal or civil. Until the DOJ announces something, we won't know, and if they do not pursue it they won't say anything at all," said Stephen Diamond, an associate professor at Santa Clara University Law School.

On Thursday, shares of the server maker that has profited from the AI boom tumbled 12%, but trading was halted three times due to volatility. Shares ended the day ay $402.40, a serious comedown for the stock, which hit a high in March of around $1,188. It is the S&P 500's SPX worst performer over the past three months.

In August, when it released its fiscal fourth-quarter results, Super Micro also announced a 10-for-1 stock split, scheduled to take effect on Oct. 1.

The report from Hindenburg Research, which came out Aug. 27, alleged a range of issues related to the company's internal financial controls, including a whistleblower suit against the company. The following day, Super Micro said that its annual report would be delayed because it needed to review its internal controls.

"The board of directors has formed a committee to review certain of the company's internal controls and other matters," Super Micro said in an SEC filing last month. It added that it does not expect any material changes to its financial results for fiscal 2024.

This news, however, brought up an old wound for investors, which was highlighted in the Hindenburg Report - namely Super Micro's past issues with financial controls. In 2020, the Securities and Exchange Commission charged the company with prematurely recognizing revenue and understating expenses over a period of at least three years. Co-founder and CEO Charles Liang was not charged with misconduct but had to reimburse the company $2.1 million in stock profits he received while accounting errors were occurring.

The whistleblower lawsuit disclosed by Hindenburg in August was filed by a former executive, Bob Luong, alleging that Super Micro retaliated against him after he reported his concerns about improper revenue recognition and allocation.

One example, according to the lawsuit filed in federal court in the Northern District of California in April, described incorrectly allocating revenue to overstate profit margins in hardware. The suit alleges that in December 2020, Luong reported to Kenneth Cheung, the controller overseeing revenue recognition, that one of his subordinates had incorrectly allocated more than $10 million of revenue to hardware sales rather than service, which misleadingly overstated the profitability margin associated with the hardware sales. Among his other allegations, Luong also contended that Super Micro re-hired many of the same people it had previously fired in its house-cleaning effort after the 2020 SEC charges.

Super Micro has filed a motion to compel in federal court, seeking that the case be heard in arbitration, per Luong's employment agreement that he first signed in 2012. In a hearing Thursday, the court took the filing under advisement.

"Super Micro's attempts to cover this up continue even after he filed a lawsuit as they seek to force this matter into arbitration where the evidence against them would be obscured from public view, undermining the public interest and that of their shareholders," said Luong's attorney, Tanya Gomerman, in a statement. "We know there are other witnesses with knowledge of this alleged fraud and we strongly encourage them to come forward."

The company is also facing several shareholder lawsuits seeking class-action status alleging that executives made false statements about the company's internal accounting controls.

It is not clear whether the DOJ is looking at the whistleblower's allegations, or other contentions in the Hindenburg report. Hindenburg also alleged that Super Micro has evaded sanctions and export controls and as an example, claimed that third-party exporters were selling systems to Russia, after the U.S. banned technology sales there after the invasion of Ukraine in 2022. Super Micro said in its last annual report for fiscal 2023, filed with the SEC, that is has "paused sales to Russia, Belarus and the restricted areas in Ukraine," after the U.S. restrictions were put in place.

"Firms like Hindenburg, of course, have a one-way bet on this so their report has to be appropriately discounted," said Diamond. "They are what is known as 'activist' short sellers who not only go short but also then follow up with public reports attempting to trigger a stock-price drop."

Investors had a wild ride with Super Micro shares. That roller coaster may now continue on its downward descent, until the uncertainty surrounding these various cases and issues is resolved. Until then, investors should proceed with caution.

-Therese Poletti

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09-27-24 0800ET

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