Fiat Chrysler's alleged cheating shocks investors, not dealers

When two dealerships owned by a Chicago-area group last week accused Fiat Chrysler of falsifying sales reports, it did two things: cratered FCA's share price and launched yet another discourse about the industry's integrity.

A civil racketeering suit filed in Chicago by two stores in the Napleton Automotive Group alleges FCA US offered dealers large sums of money to report unsold vehicles as sold. FCA vigorously denied the allegations, calling them "baseless" and "the product of two disgruntled dealers who have failed to perform their obligations" within their dealer agreements.

But the suit set off alarms. Dealers take carmakers to court all the time, so why did this one lawsuit strip more than $1 billion from FCA's market value?

Analysts say it's largely nervousness -- about FCA's ability to complete its ambitious goals by 2018 and over whether the entire scandal-plagued, plateauing industry can be trusted.

"In our opinion, the emergence of these allegations point to a possible weakness in sales quality," said David Lim, senior analyst with Wells Fargo Securities. "We would not be surprised if other OEMs followed a similar tactic to varying degrees."

The plaintiffs, Napleton Arlington Heights Chrysler-Jeep-Dodge-Ram in suburban Chicago and Northlake Chrysler-Jeep-Dodge-Ram in Lake Park, Fla., are part of the Napleton group of Westmont, Ill., owned by Edward Napleton. The group, which operates dealerships in Illinois, Florida, Pennsylvania, Missouri and Indiana, ranks No. 32 on Automotive News' list of the 150 top U.S. dealership groups, with 2014 retail sales of 21,550 new vehicles.

Among the allegations in the lawsuit:

• FCA officials rewarded district sales managers for hitting sales targets -- even though they knew the sales goals had been met only by way of false sales reports.
• One of FCA's business center managers at one point allegedly offered Edward Napleton a disguised $20,000 payment "to falsely report the sales of 40 new vehicles" at the end of an unspecified month.
• An unidentified competitor conspired with FCA and reported 85 false new-vehicle delivery reports and received "tens of thousands of dollars as an illicit reward" as a result.

Napleton Automotive has retained attorney Leonard Bellavia, who specializes in dealer litigation, to prosecute the case. Bellavia and Edward Napleton declined to provide additional details on the allegations.

Investors banged away at most auto stocks last week, yet they hammered FCA particularly hard. In Milan, trading in FCA's shares had to be halted temporarily after word of the Napleton suit reached Italy.

FCA has reeled off 69 straight monthly sales increases and was the only Top 5 automaker to grow its U.S. market share in 2015. But analysts worry about the company's underlying fundamentals and have questioned whether FCA can complete its ambitious 2014-18 business plan. The plan relies heavily on a global resurrection of Alfa Romeo to help FCA eliminate its net debt and clear 9 billion euros ($9.86 billion) of annual operating profit.

At the Detroit auto show earlier in the week, FCA CEO Sergio Marchionne said the company has tabled its effort to find a merger partner to focus on achieving its business plan.

"The immediate focus for all of us [at FCA] ... is to achieve the 2018 plan," Marchionne said. "That is the key priority for this house, because achieving the 2018 plan puts this house in a completely different condition about consolidation that must happen."

Arndt Ellinghorst, analyst at Evercore ISI, said FCA's condition may be more worrisome than the Napleton suit.

"To be clear, we have no reason to believe that FCA has breached any law in the U.S.," Ellinghorst wrote. "What we can say though is that FCA carries among the highest dealer inventory level in the industry with passenger car stock of 109 days of supply. In a U.S. market where customer preference is materially shifting towards SUVs and light trucks, [FCA] carries a worryingly high level of dealer stock."

FCA called the plaintiffs in the Napleton lawsuit serial underperformers: "They have consistently failed to perform since at least 2012, and have also used the threats of litigation over the last several months in a wrongful attempt to compel FCA US to reserve special treatment for them, including the allocation of additional open points in the US FCA network."

But FCA executives say they are aware of the pressure on the company's 2,650 dealers to perform -- and that they don't always do so. In interviews last week, company leaders said they are studying, for example, ways to ease the strain on struggling Fiat dealerships, though they didn't go into specifics.

Dealers also said FCA has amended its Volume Growth Program, the company's stair-step incentive program, this month to allow dealers to receive a factory incentive payout after reaching 90 percent of the monthly sales goal, instead of paying nothing unless 100 percent of the goal was reached.

One large dealer told Automotive News that he sold more than 200 new cars in one month last year, yet lost more than $100,000 in the month because the dealership missed its Volume Growth Program goal.

The lawsuit also generated new buzz about an old topic within the industry -- an apparently widespread belief that when it comes to cheating on sales reporting, "everyone does it."

In comments online and privately about the Napleton suit, dealers seemed nonplussed by allegations of factory pressure and falsified sales reports, which FCA denied.

"Everyone has been doing it for years," said one dealership executive. "If you're going to go after FCA, then you've got to go after every [automaker], because everyone does it to some extent."

But bringing up the topic in a lawsuit puts a new light on the old issue -- in an industry with a reputation that has been put through the wringer after several scandals.

"The core problem for the industry has been a series of failures over governance and improper goal setting," said activist investor Harry Wilson at the Automotive News World Congress last week. He added that auto companies "have some historically bad challenges with credibility."