Class Action Lawsuit Filed Against GM For Channel Stuffing

Tyler Durden's picture

In a classic example of "speak of the devil", we were barely done with hitting save on our earlier article (in a series going back to 2011) describing the relentless (and innovative) machinations conducted by GM to perpetuate the myth of swift sales absorption when in reality it is nothing the age-old gimmick of channel stuffing, that we got notice that General Motors was being sued by a group of IPO investors (nursing losses of about 40%), for precisely this: "In connection with the IPO, and in order to assuage concerns that GM was predicting revenue based on production rather than actual sales, GM falsely assured investors that it was actively managing its production by monitoring its dealer inventory levels. Additionally, GM assured investors that in 2011 it would improve inventory management, which would improve average transaction price. These statements were false when made. In July 2011, reports began to surface that GM had engaged in an extraordinary inventory build-up. In particular, an article published by Bloomberg on July 5, 2011 revealed that GM may have been unloading excessive inventory on dealers, a practice known as "channel stuffing," in order to create the false impression that GM was recovering and sales and revenues were rising." Luckily, since this is a class action lawsuit, anyone else out there who bought GM on the belief that the company would not engage in precisely the behavior that we have shown month after month to occur, is invited to enjoin the plaintiffs and to sue the company that exists only courtesy of taxpayer generosity (and more importantly, courtesy of labor unions subverting priority rights in bankruptcy, in exchange for presidential votes). Finally, and if nothing else, this lawsuit will certainly force the general co-opted media to pay some more attention to a topic that is quite sensitive for the administration: the business model of the one company that the president is so proud and happy to have saved from the clutches of evil bondholders.

From the lawsuit:

On July 5,2011, Bloomberg published an article revealing that in the months just prior to the IPO and thereafter, GM already was falling into "old, bad habits" by "channel stuffing," a practice whereby excess inventory is "sold" to dealerships so that the manufacturer, in this case, GM, can record those sales on its books, creating the false appearance of revenues, even while those cars remain unsold on dealer lots. The article stated that GM's truck inventory swelled to 122 days worth of average sales whereas, by comparison, GM's less profitable car inventory was limited to 60 to 70 days of average sales, Ford was maintaining only a 79 day inventory on comparable trucks, and GM's truck inventory during the years 2002-2010 had similarly averaged only 78 days of average sales.

The article quoted an analyst from Jefferies & Co. stating that "[i]t's unbelievable that after this huge taxpayer bailout and the bankruptcy that we are right back to where we were." The analyst further stated, "There's no credibility."

The article also quoted an executive director of global forecasting at J.D. Power & Associates, who stated that even though trucks may require more inventory to meet the demand for different combinations of weight classes, cab types, engines and trim levels, an inventory of over 100, a figure more than 20% less than the 122 average attributed to GM, would be excessive. This expert stated that while a truck supply in the 70s or 80s "isn't considered high ... When you're north of 100, it suggests there's too much." He added that "[ e]ven if you need a lot of variety, that's still pushing it."

Indeed, on July 1, 2011, GM admitted on an investor conference call that it had substantially exceeded inventory targets. An article appearing on Barron's on July 5, 2011 quotes Don Johnson, the VP of GM's U.S. sales operations, who stated on an investor call that "[r]ight now we are at 122 day supply on full-size pickups. And this is slightly above where we would like to be. I acknowledge that our target is between 100 and 110 day supply but I think it's important that people realize why we are there and what we may do about it." Thus, GM acknowledged that its target was above the 100 vehicle figure that industry experts  considered excessive, and moreover GM exceeded even its own excessive target.

Similarly, a December 1, 2011 post on an investor website suggested that GM's monthly disclosure of car sales was completely irrelevant in light of the huge run-up in dealer inventories, which indicated that production greatly exceeded demand. In fact, GM's month-end dealer inventory in November 2011 reached what was then an all-time high of 623,666 cars, which was 3.5 times the total GM vehicles sold in that month.

As of November 2011, GM dealer inventories were 30 percent higher than they were on September 30,2010 (the end of the last full quarter before the  November 18,2010 IPO) and 62 percent higher than they were at the end of 2009. Seemingly undeterred by these statistics, GM's dealer inventories have continued to rise.

DEFENDANTS'MISREPRESENTATIONS

On November 18, 2010, GM filed a prospectus on Form 424B1 with the Securities and Exchange Commission in connection with the Company's IPO (the "Prospectus"). The Prospectus stated, among other things, that "We aim to increase our vehicle profitability by maintaining competitive incentive levels with our strengthened product portfolio and by actively managing our production levels through monitoring of our dealer inventory levels." See Prospectus at p. 6.

This statement was misleading at the time it was made, because GM did not have adequate inventory controls in place and did not monitor dealer inventory levels to ensure that production was consistent with demand. Instead, in the months following the IPO, GM continued to ramp up production and overload dealerships with excess inventory, which GM then recorded as sales, even though the vehicles remained unsold on dealer lots for longer periods of time.

The Prospectus also stated: "At September 30, 2010 Inventories of $13.0 billion increased by $2.9 billion (or 29.1%), primarily due to: (1) increased  production resulting from higher demand for our products and new product launches; and (2) higher inventory levels at September 30, 2010 compared to low levels at December 31, 2009 of $5.9 billion that resulted from the year-end shut-down in certain locations." See Prospectus at p. 90. This was false and misleading, because the increased inventories were the result of channel stuffing and were not attributable to higher demand. Indeed, at the time of these statements, dealer inventories were rising and trucks were sitting unsold on dealer lots for longer periods of time.

This statement was false and misleading when made, because the increases in vehicle sales data were the result of channel stuffing and were not attributable to higher demand. In addition, the majority of sales reported by GM were based on estimated sales to final customers and not on actual sales data, and therefore, did not accurately reflect underlying demand. See Prospectus at p. 75.

LOSS CAUSATION / ECONOMIC LOSS

Defendants falsely stated in the Prospectus that GM was actively managing production levels through the monitoring of dealer inventory levels, and that  increased inventories were attributable to and indicative of higher demand. Defendants also failed to correct these previous false statements.

The false statements and omissions described above caused GM's stock price to remain artificially inflated.

Starting in July 2011, when the risk inherent in GM's lack of proper inventory controls materialized, GM's share price fell by more than 30%, representing a  market cap of in excess of $8 billion.

A March 2012 article in The Atlantic blamed the stock price collapse on investor fears that GM had not shaken its former bad habits, including possible channel stuffing.

 

Full lawsuit here: