EY Jumps Ship, SMCI Plunges 30%: A Look at the Cost of Fraud in US Stocks

Thursday saw a broad market selloff: Dow -0.9%, Nasdaq -2.76%, S&P 500 -1.86%.

After the close, the US October Chicago PMI came in at 41.6, sharply below the expected 47, and down from 46.6 in September. The Chicago PMI has been below the 50 threshold for 11 consecutive months, with the contraction deepening in October. Boeing's ongoing strike dragged down production.

Before the open, the PCE index rose 2.65% year-over-year, slightly above the 2.6% estimate but below the prior 2.7%. Core PCE was 2.7% year-over-year, in line with the prior month and above the 2.6% estimate; month-over-month core PCE rose 0.3%, in line with expectations but above the prior 0.1%.

Trump-related stocks fell 40% in recent days, and Polymarket odds for a Trump victory saw a notable decline.

Separately, SMCI, once a high-flying AI semi stock, is facing a serious crisis of confidence.

The initial trigger was a whistleblower complaint from an SMCI employee named Luong. This has reopened questions about SMCI's integrity—and this is not the first time: in 2018, SMCI was delisted due to accounting fraud.

Two days ago, SMCI's independent auditor, Ernst & Young (EY), resigned over concerns about governance and financial transparency, citing a lack of trust in management's integrity and the reliability of financial statements. The board has formed a special committee comprising Cooley LLP and Secretariat Advisors to conduct a review.

Below is a translation of the relevant filing:

On October 24, 2024, Ernst & Young LLP (“EY”) sent a letter to the Audit Committee members resigning as the Company’s independent registered public accounting firm (the “Resignation Letter”).

The Chair of the Audit Committee discussed the reasons for EY’s resignation with EY. The Company has begun a process to engage a new independent registered public accounting firm. Once selected, the Company will authorize EY to respond fully to the inquiries of the successor independent registered public accounting firm. The Company currently does not expect that the matters raised by EY or considered by the Special Committee, as described below, will result in any restatement of its quarterly reports for the fiscal year ended June 30, 2024 or prior fiscal years.

EY was engaged on March 15, 2023 to audit the Company’s financial statements for the fiscal year ending June 30, 2024, and has not yet issued any report on the Company’s financial statements or on the Company’s internal control over financial reporting. EY resigned while performing its audit of the Company’s financial statements for the fiscal year ending June 30, 2024, which is the first audit EY has performed on behalf of the Company.

In late July 2024, EY communicated to the Audit Committee concerns regarding the Company’s governance, transparency and completeness of communications with EY, and other matters related to the Company’s internal control over financial reporting, as well as a material risk that the Company’s Annual Report would not be timely filed. In response, the Board appointed an independent Special Committee (the “Special Committee”) to review these matters and certain of the Company’s internal controls and certain governance procedures (the “Review”). The Special Committee engaged Cooley LLP and the forensic accounting firm Secretariat Advisors, LLC to conduct an investigation on behalf of and at the direction of the Special Committee. EY and the Board received preliminary information updates related to the Review. As of the date of this Current Report on Form 8-K, the Review is ongoing and final findings and recommendations have not been communicated to EY or the Board.

After receiving additional information during the course of the Review, EY informed the Special Committee that the additional information received by EY raised questions, including whether the Company has demonstrated a commitment to integrity and ethical values consistent with COSO Framework Principle 1, and whether the Audit Committee and the Board as a whole are able and willing to act as an independent oversight body separate from the CEO and other members of management consistent with COSO Framework Principle 2, and whether EY can rely on the representations of certain members of management and the Audit Committee. In the Resignation Letter, EY stated, in part: “We are resigning because information that has recently come to our attention has led us to no longer be able to rely on management’s and the Audit Committee’s representations and we are unwilling to be associated with the financial statements prepared by management, and after concluding we can no longer provide audit services in accordance with applicable laws or professional obligations.”

Although the Company acknowledges that EY’s decision is final, it disagrees with EY’s decision to resign as the Company’s independent registered public accounting firm—the Special Committee has not yet obtained all relevant information related to the Review, and has not yet completed the Review. Nonetheless, the Company takes the concerns expressed by EY seriously and will carefully consider the findings of the Special Committee and any remedial or other actions recommended by the Special Committee upon conclusion of the Review.

Except as described above, during the fiscal years ended June 30, 2023 and 2024 and the subsequent interim period through EY’s resignation, (1) there were no “disagreements” with EY on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure, which, if not resolved to EY’s satisfaction, would have caused EY to make reference thereto in its reports, and (2) there were no “reportable events” as described in Item 304(a)(1)(v) of Regulation S-K.

The Company has provided EY with a copy of the disclosures required by Item 304(a) of Regulation S-K in Item 4.01 of this Current Report on Form 8-K and has requested that EY furnish the Company with a letter addressed to the U.S. Securities and Exchange Commission stating whether it agrees with the Company’s responses to these requirements, and if not, the respects in which it does not agree. A copy of EY’s letter, dated October 29, 2024, is filed as Exhibit 16.1 to this Current Report on Form 8-K.

As of now, SMCI has not yet filed its annual report for the prior fiscal year. Under relevant rules, if SMCI fails to file by November 16, it could face suspension. SMCI plans to hold an earnings call and provide a business update on November 15.

Historical US Stock Fraud Cases

1. Luckin Coffee Overview: After its 2019 IPO, Luckin Coffee fabricated revenue and expenses. In April 2020, Luckin self-disclosed that its COO and some employees had engaged in misconduct since Q2 2019, involving approximately RMB 2.2 billion in fake sales. The stock crashed, market cap evaporated, and it was delisted from Nasdaq. Cost: Luckin settled with the SEC, agreeing to pay a $180 million fine. Delisted from Nasdaq. Management overhaul: founder Lu Zhengyao was ousted, and Guo Jinyi took over as chairman and CEO. Reputation damage: severe loss of trust, requiring significant effort to rebuild.

2. Theranos Overview: Founded by Elizabeth Holmes in 2003, Theranos claimed to diagnose dozens of health conditions from a few drops of blood from a finger prick. By 2015, it was valued at $9 billion, and Holmes was named the world's youngest female billionaire. However, the Wall Street Journal exposed serious issues with its blood-testing technology, including inaccurate results and concealed facts. Cost: Holmes was convicted on 4 of 11 counts of fraud and conspiracy, facing up to 20 years in prison and a $250,000 fine plus restitution. The company filed for bankruptcy and dissolved within months of the scandal.

3. FTX Overview: FTX was a top-5 crypto exchange founded by Sam Bankman-Fried. In November 2022, FTX filed for bankruptcy after reports of insolvency triggered a bank run. Cost: The company went from a $32 billion valuation to zero in less than ten days. Investors including Sequoia, SoftBank, and Temasek suffered massive losses. The collapse triggered a crisis of confidence in the crypto industry, prompting other platforms to disclose reserve funds to prove solvency.

In summary, the cost of financial fraud in US stocks is extremely high. Any fraud taints management and corporate governance with an untrustworthy label. If SMCI's fraud allegations are confirmed, the company will likely be left behind in the current tech and AI wave. Investors should closely monitor the risks.

Risk Disclosure: The views expressed are for informational purposes only and do not constitute investment advice. Market risk exists; invest with caution.

Like, reply "24Q4" to get the above content. Interested? Hit follow before you go~