On March 6, Mullen Automotive (NASDAQ:MULN) was dealt a one-two punch after its accounting firm, Daszkal Bolton LLP, announced it was resigning. The 150-person Florida-based firm will be replaced by a far smaller NYC-based outfit, RBSM LLC.
The same day, the automaker missed a deadline to meet the minimum $1 share price for Nasdaq listing compliance.
Together, that’s pretty bad news. Investors have long known that 1) downsizing an auditor and 2) sub-$1 share prices are recipes for delisting. And although Mullen continues to impress with its constant stream of updates, the firm’s aggressive financial decisions are a recipe for losing it all.
Why Would Mullen’s Auditors Resign?
Every public company trading on the Nasdaq or New York Stock Exchange must publish audited financials at least once yearly. It’s how stock exchanges and investors know the company isn’t making up numbers… or at least are trying hard enough to fool well-paid pros.
Remember, these auditors don’t always have the same incentives as external shareholders. The companies they audit pay them directly, so the accountants are often more interested in pleasing management than serving shareholders. The Enron scandal, for instance, was only possible with the help of accountants at Arthur Andersen. And accountants for FTX, a disgraced crypto exchange, are now accused of being “willfully blind” to a pattern of “racketeering.”
Still, most audit firms have a sense of self-preservation. According to the American Accounting Association, a leading explanation for auditor resignation is litigation risk, the risk that an auditor will get involved in a lawsuit. If a firm goes down for accounting fraud, its auditor often does too.
Mullen’s case is particularly noteworthy because its audit firm resigned after announcing a merger with the far larger CohnReznick LLP, a top-15 accounting firm with around 4,000 employees. Larger firms are typically more sensitive to litigation risk (a product of the Arthur Anderson collapse) and Mullen’s six-figure contract with Daszkal Bolton didn’t make the cut.
It’s not hard to see why. Mullen’s Q2 2022 partial acquisition of Bollinger Motors was filled with aggressive accounting practices. That included $77 million of cash that might have made a “round trip” among related parties and liberal assumptions on patent valuation. The Electric Last Mile Solutions acquisition was no less eyebrow-raising, with $55 million assigned to vague terms, likely to avoid getting categorized as “goodwill.”
I’ve long warned that Mullen’s balance sheet is not as strong as it appears. Daszkal Bolton’s resignation adds to this theory.
Does the Minimum $1 Share Price Matter?
Then there’s the issue of Mullen’s sub-$1 share price.
On Jan. 19, a largely predetermined vote authorized a reverse stock split for Mullen’s shares. The proposal would allow up to a 1-for-25 reverse split anytime until December 2023.
On the surface, the $1 listing requirement seems a non-issue.
Yet, Mullen’s management has been vocal about avoiding a reverse split until all compliance extensions run out, possibly around September 2023.
Studies show that such foot-dragging increases the chance of an eventual delisting. The NYSE and Nasdaq exchanges weigh multiple factors in their decisions, so oversights add up. For instance, a company with a sub-$1 price and late filings is at greater risk of getting dropped than a firm with only one issue. It’s a fact that former meme stock Helbiz (NASDAQ:HLBZ) quickly learned in January.
According to a study in the Journal of Finance and Economics, the average sub-$2 company that fails to reverse split only survives another 6.7 months on average.
Mullen’s position on the Nasdaq Capital Markets also raises the risks. The lower-tier exchange adds additional rules that can make it harder for companies to regain compliance.
What’s Next for Mullen Stock?
History provides little comfort for Mullen’s shareholders. A 2001 paper by researchers at Indiana University found that stock prices typically fall 4.8% the day after a company announces an auditor resignation and drop another 12.1% over the following 60 trading days.
The performance is even worse among firms that fail to disclose a reason for the resignation. Companies that did not cite accounting concerns for their auditor’s resignation saw shares drop an additional 2.5%.
Then there’s the specter of a reverse split, a negative event that tends to depress share prices. A separate study showed that companies undergoing reverse stock splits see shares drop anywhere from 22.7% to 43.6% over the following three years.
Will MULN Stock Recover?
Of course, none of this means Mullen’s stock will suddenly go to zero. CEO David Michery has done a masterful job keeping his electric vehicle startup alive, and retail investors continue to like the stock. The evidence I laid out above is also the average of thousands of companies. Mullen is no average firm.
Mr. Michery has also given Bollinger CEO Robert Bollinger free reign over the subsidiary. You can read more about InvestorPlace’s interview with Robert Bollinger here. This “company-within-a-company” can generate exceptional value, as former Intel (NASDAQ:INTC) subsidiary Mobileye (NASDAQ:MBLY) and others will know.
Still, don’t be surprised if Mullen someday decides it needs to restate its financials or announces it’s losing an exchange listing. For all of Mr. Michery’s dealmaking, history shows that the laws of finance will eventually come back to bite.
On the date of publication, Tom Yeung did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.