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- Recent developments suggest that B. Riley is controlling managerial decisions at Applied Digital to the detriment of Applied Digital shareholders
- After raising “low-cost” debt from B. Riley specifically for the purpose of “accelerating growth”, Applied Digital turned around and paid the loan off almost two years ahead of contractual maturity, and at the exact time that B. Riley needed to raise cash for its FRG acquisition
- We do not believe that Applied Digital’s board meets the independence requirements under Nasdaq rules and believe the Board is essentially controlled by B. Riley
- The CEO of APLD bought shares of APLD utilizing his B. Riley fund immediately in front of significant market moving news – we believe the Boards of both companies should probe these trades
- Given the clear conflicts of interest at play, the Audit Committee’s alleged investigation into the CEO’s sexual harassment could subject Applied Digital to significant legal blowback
Applied Digital represents one of the worst governance situations we have ever seen and we expect both APLD and RILY could face substantial litigation in the coming months due to severe disclosure and governance problems. We question the judgment of partners that have decided to work with Applied Digital despite its internal control (p17) and governance problems.
In this article we focus on the legal issues in front of Applied Digital that we believe can spillover to B. Riley because of the company’s improperly disclosed relationship. Unbelievably, nowhere in APLD’s 2022 10-K does the company mention a risk factor relating to its relationship to B. Riley despite the obvious conflicts of interests including the CEO holding a dual role as a fund manager at B. Riley, the CEO using B. Riley funds to trade shares of APLD, and 3 of 6 board seats being held by senior B. Riley executives or their spouse. We think the lack of disclosure on this matter subjects both companies to substantial legal risk.
Applied Digital currently has 6 Board members, 5 of whom the company claims are independent. Nasdaq listing requirements require “a majority” of the Board to be independent. However, as we analyze below, both Mr. Hastings and Ms. Moore (the wife of the CEO of B. Riley Securities) do not appear to be independent and, even if they may technically fit the definition, they clearly open the company up to significant legal liabilities.
Amazingly, Ms. Moore Chairs the Nominating Committee and Mr. Hastings also sits on it (2 of 3 seats). As such, they are tasked with determining the independence of the members of the board. There is no way two B. Riley linked individuals can determine their own independence given the linkages. More on this below.
As such, we believe that Applied Digital’s current Board has only 3 truly independent directors, representing less than a majority and potentially running afoul of Nasdaq listing requirements. Nasdaq rule 5605(a)(2) requires a majority of a board to be independent (meaning more than 3 seats), and Mr. Cummins as Chairman clearly tilts the board towards lacking independence.
We think this matters because there is evidence B. Riley is influencing managerial decision making at Applied Digital, thereby effectively exercising control over the company. This is not disclosed as a possible risk factor in the company’s SEC filings.
Below we demonstrate examples of instances in which B. Riley’s influence on Applied Digital suggests that Applied Digital’s Board of Directors is putting B. Riley’s interests ahead of Applied Digital shareholders – making short term and conflicted decisions that are favorable for Mr. Cummins and B. Riley and not for shareholders.
Rapid B. Riley Loan Paydown Suggests B. Riley Is Influencing Company Decision Making
Applied Digital recently classified a loan from B. Riley to Applied Digital as a “related party loan”, which itself calls into question how anyone linked to B. Riley could possibly fit the definition of independent board member. The loan had a 2 year maturity yet Applied Digital prioritized paying back its loan from B. Riley – getting the loan in May and paying it back in July according to the recent earnings call. Notably, Applied Digital classified the loan as a “long term related party loan” as of its May 2023 balance sheet. What transpired that caused the company to change its mind and pay it off in short order?
In the May 19 PR touting the loan (titled “New $50 Million Loan to Accelerate Growth”), the CEO remarked that the loan “is a continued endorsement of the strength of our business and illustrates our ability to secure low-cost, non-dilutive financing to fund a portion of our growth capital needs.” Yet we know that by July 24, the loan had been paid down after the company launched a highly dilutive equity offering (CFO David Rench said the loan was paid down on the earnings call). This suggests the potential that B. Riley received preferential treatment of its loan at the expense of shareholders.
Notably, on July 25, B Riley announced that it was conducting a $100 million equity offering. It also disclosed to investors that it owed $250 million for its acquisition of FRG (pg S-9) and may need to raise debt to pay for that acquisition. In other words, B. Riley was tight on cash.
As such, it is obvious that B. Riley needed cash and the timing of Applied Digital paying B. Riley off coincides perfectly with meeting B. Riley’s cash needs. As such, it appears that Applied Digital management made a decision that put B. Riley’s interests ahead of its own. The loan had a 2-year maturity and Applied Digital had need for growth capex. B. Riley appears to have no early call right. It made no sense to pay the loan off almost 2 years early. The CEO cannot argue he was paying off high cost debt (he described it as low-cost).
Even more amazingly – the B. Riley loan agreement required APLD to pay a 2% exit fee to B. Riley per the terms of the agreement. In other words, assuming B. Riley enforced its contract, Applied Digital wasted $1 million in fees for a loan that it held for approximately 2 months time that accrued to the benefit of B. Riley.
If investors actually believe Mr. Cummins’ claims of huge growth opportunities, then they should be irate. Instead of preserving $37 million of capital to invest in future growth, Applied Digital placated B. Riley and paid off a loan early to help B. Riley fund its acquisition of FRG. Investors should be asking what repercussions Mr. Cummins would have faced if he had chosen to not pay the loan off early? Would he have been removed as APLD CEO? Would he have been removed from B. Riley Asset Management?
One thing is clear – the company’s SEC filings provide completely inadequate disclosures relating to these conflicts of interest that are playing out in real time.
This type of favorable treatment for B. Riley is what disadvantages shareholders and is why truly independent directors are needed. It is also the type of fact pattern that could open B. Riley up to litigation over Applied Digital.
Director Independence Test
According to the Nasdaq, an “Independent Director” means a person other than an Executive Officer or employee of the Company or any other individual having a relationship which, in the opinion of the Company’s board of directors, would interfere with the exercise of independent judgment in carrying out the responsibilities of a director. Notably, the “opinions” that matter here are Mr. Moore and Mr. Hastings who sit on the Nominating Committee and make assessments as to their own independence. This does not pass the smell test.
As you consider this definition, and the events that have played out in the past weeks, ask yourself how the two profiles below could possibly meet the definition of an independent director.
Mr. Chuck Hastings Failure to Recuse Himself from Audit Committee Investigation
As background, Wes Cummins simultaneously serves as the President of B. Riley Asset Management (a role in which he operates a hedge fund within the B. Riley firm). From public SEC filings, it can be discerned that B. Riley Wealth Management (run by Chuck Hastings) is a source of capital for Mr. Cummins’ hedge fund. It is highly unusual that Mr. Cummins simultaneously serves as the CEO of Applied Digital while serving as the President of B. Riley Asset Management.
Mr. Chuck Hastings is the CEO of B. Riley Wealth Management. He therefore has a significant vested interest in Mr. Cummins and Mr. Cummins’ reputation. Reputation is paramount for money managers. Mr. Hastings’s division of B. Riley has steered capital towards funds managed by Mr. Cummins. As a result, Mr. Hastings has a significant conflict of interest in all matters relating to Mr. Cummins.
Applied Digital claims that Mr. Hastings is an independent director. This strains credulity. According to Skadden, two key tests for independence is whether a director may act in their own self-interest or have relationships with interested parties. In this case, it is clear that Mr. Hastings would be reluctant to disagree with the CEO’s version of events because it would have a negative impact on B. Riley’s reputation, regulatory standing, or even its financial health. B. Riley’s Wealth Management division would clearly prefer to not disclose sexual harassment allegations against one of its fund managers to retail clients.
When Applied Digital disclosed the sexual harassment investigation, the 8-K did not mention that Mr. Hastings recused himself from the investigation. He is a member of the 3-person Audit Committee that handled the internal investigation. This is problematic because Mr. Hastings clearly has a vested interest in the outcome of the investigation. Any negative findings in a sexual harassment investigation would read negatively for B. Riley Asset Management and would create potentially embarrassing issues for B. Riley Wealth Management as they would have to disclose information to retail investors who trust money with them. They could face fund and client redemptions.
Additionally, Mr. Hastings makes accounting calls on the Audit Committee. As described in this article, there is evidence that B. Riley is controlling the managerial decisions of Applied Digital. We believe B. Riley would not want to consolidate Applied Digital on its balance sheet – how can one expect Mr. Hastings to be objective on this accounting analysis when he has a superseding loyalty to his employer B. Riley?
In our view, the fact Mr. Hastings did not recuse himself voluntarily from the Audit Committee investigation demonstrates that he is not acting appropriately and independently given he undeniably had vested interests in the outcome of the investigation. We think this opens his independence up to challenge.
Virginia Moore, Wife of Andy Moore, Is Also Likely Not Independent
The CEO of B. Riley Securities is Andy Moore. His wife is on the Board of Applied Digital. She too is called an independent director by Applied Digital. Both husband and wife own stock in Applied Digital. B. Riley Securities handled the IPO for Applied Digital, made a loan to Applied Digital recently (classified as a related party loan in the most recent 8K outlining the earnings release), and publishes research about Applied Digital (as a side note there is no risk factor in APLD’s 10-K describing how or if walls are utilized at B. Riley to ensure that Mr. Cummins’ knowledge from Applied Digital can end up in the hands of the Securities Division that writes research on the company).
On Twitter, I asked Mr. Moore about his wife’s involvement in the company. His reply below leads me to believe that Ms. Moore is not independent as he essentially stated that Ms. Moore was a “familiar relationship” who the company (presumably Wes Cummins and/or B. Riley) “trusts”. Either way this exchange does not seem to fit the bill for independence. His familiar relationship language appears to run afoul of the language in the Nasdaq description of an independent director.
It is worth noting that APLD is around a $1B market cap company today and has been public since April 2022 – Mr. Moore’s arguments seem to fall flat.
Again, B. Riley Securities faces similar conflicts of interest to B. Riley Wealth Management. Mr. Moore is its CEO. It is all housed under B. Riley Financial, which according to p4 of this regulatory document, is the owner of B. Riley Asset Management. Mr. Cummins, CEO of Applied Digital, is also the President of B. Riley Asset Management.
So, it stands to reason that Virginia Moore, married to Andy Moore, would not want to besmirch B. Riley’s reputation, or question the CEO of Applied Digital on his decision making because of the possible knock-on effect. Her household’s income depends on the stability and reputation of B. Riley.
Given the facts above, we think lawyers, shareholders and regulators looking to bring suits against Applied Digital and/or B. Riley will view the company’s definition of “independent director” problematically. Additionally, the Board only has 3 of 6 members who are “truly independent” in our view which does not constitute a majority as required under Nasdaq rules, particularly given that the Chairman role is held by the CEO.
Sexual Harassment Investigation
A HR consultant compiled this article that provides strong legal analysis of the ongoing sexual harassment allegations against Applied Digital’s CEO. It is worth a read. After reading that third party expert post, our only conclusion is that Mr. Cummins’ would have likely lost his job at a public company that was not stacked with B. Riley linked individuals who had a reason to cover up this episode. It appears to us that a B. Riley controlled board acted to maintain Mr. Cummins’ employment.
Chuck Hastings sat on the Audit Committee that investigated the CEO and is clearly conflicted. And both Ms. Moore and Mr. Hastings sit on the Nominating Committee that is responsible for overseeing governance guidelines and providing waivers for violations of codes of ethics. The entire investigation can be viewed with great skepticism and it seems likely that should Ms. Ingel hire legal counsel, they will pick apart the conflicts present in this board. It would have made sense for the company to start enhancing its corporate governance right now but we see no sign of that in any disclosures or actions thus far.
B. Riley Asset Management Trading In Applied Digital Shares Warrants Significant Scrutiny
I wrote a letter to the Chair of the Audit Committee of B. Riley outlining the trading below and requesting an investigation into whether the trading is compliant with insider trading laws.
As a starting point, we find it highly irregular that the CEO of a public company is simultaneously managing an investment fund and trading shares of his own company in that investment fund on an open market basis.
Wes Cummins reported a series of open market purchases of shares of APLD in April and May of 2023. The purchases were all on behalf of B. Riley Asset Management.
The purchases were as follows:
25k on 4/12/23
25k on 4/13/23
25k on 4/14/23
10k on 5/17/23
We were so taken aback that this trading occurred given the timing that we even ran it down in 3rd party insider trading databases and confirmed it. The below screenshot is from Nasdaq.com:
The stock was thin and illiquid for most of the time B. Riley Asset Management was purchasing shares. Thin markets are easier for insiders to take advantage of – as can be seen below, the stock traded under $2mm a day for most of April and May. The very fact that the CEO was buying shares during a period of low volume trading that turned into extremely high volume trading is problematic as it shows empirically that the stock price began to react more to “news”.
Importantly, throughout this entire time period, Mr. Cummins was privately negotiating and finding new clients for Applied Digital, including “AI customers” that Mr. Cummins believed would result in a major positive shift for Applied Digital going forward. Most public companies use a blackout period to prevent insiders from trading on non-public information. Given the growth aspirations of Applied Digital during this time period, it is unusual that he traded shares in the company on the open market.
The shares show up as insider purchases because Mr. Cummins is the President of B. Riley Asset Management and effected these purchases himself as the control person for B. Riley Asset management.
B. Riley Asset Management is, according to Form ADV data, owned by B. Riley Financial. In our experience, large financial firms create restricted lists when the firm is in possession of MNPI. B. Riley should have restricted trading in shares of Applied Digital in the days leading up to it announcing a loan. It is surprising that Applied Digital is not always on the restricted list as it is hard to imagine how the CEO of Applied Digital is ever not in possession of MNPI. This is why executives adopt 10b5-1 plans to avoid risking violating insider trading rules.
The timing of these purchases is highly problematic in our view. The purchases were all directly in front of major contract announcements, an enormous spike in trading volume, and took place intra-quarter during periods that would normally be blacked out. The stock tripled from $3 to $10 over the course of a few weeks after this insider buying spree. Both Mr. Cummins and B. Riley were aware of plans for Applied Digital to raise capital, sign major contracts, and were aware of operating performance not disclosed to the market. The announcements were major stock moving events and liquidity in the stock materially improved after the announcements.
For example, the most troubling example is the 5/17 purchase. The purchase took place 2 days prior to the company filing a press release stating it had raised $50mm in debt financing from B. Riley. The reporting person (Mr. Cummins) is an executive of B. Riley AND Applied Digital so there is almost no question he would have been negotiating and aware of the loan when he purchased on 5/17, 2 days earlier. It is simply implausible that he did not know that B. Riley was about to lend him money when he simultaneously works for both companies and was negotiating the loan. The stock rallied 16% on 5/19 after the morning press release (which also proves that the market viewed the financing favorably – would that have been the case if the company had told investors that B. Riley wanted the money back two months later?).
All of B. Riley Asset Management’s trading was in front of this. The CEO traded directly in front of this material event. According to Applied Digital’s company handbook, possible MNPI includes “significant financing transactions or borrowings”. The purchase also took place only 24 hours after the company announced its first AI client and about one month prior to the company announcing its second AI client. None of these legal agreements are public even as of today.
If the company’s recent announcements are to be believed, then Wes Cummins was in a unique position relative to the market throughout 1H23 and especially when he was buying shares for B. Riley Asset Management. This begs the question of whether these trades were pre-cleared, who pre-cleared them, and whether both B. Riley and Applied Digital are properly policing MNPI at their firms.
The dollar amounts look relatively small at first (a total of 85k shares purchased at an average of around $300K total purchase price). But those shares are now worth around $850K. Regulators have taken issues with smaller gains, and the trading here is just bizarre because the CEO took knowledge he had from his public company job to enrich his other employer B. Riley. The dollar gains aside, the fact that the CEO actively traded in his company’s shares using his investment fund and that this was never disclosed in APLD SEC filings as a risk factor is remarkable.
We think this entire fact pattern requires an internal investigation. Again, one cannot trust the Audit Committee’s independence on this matter as we know that at least Chuck Hastings has a significant vested interest in not exploring this topic given the implications it may have for B. Riley Wealth Management.
Conclusion
In our view, B. Riley effectively controls managerial decisions and the board of directors at Applied Digital. This was never disclosed as a risk factor to APLD shareholders but recent developments establish elements of control. Neither company is being forthcoming about this control relationship. We come to this conclusion because a) Wes Cummins is CEO/Chairman of the Board and is President of B. Riley Asset Management, b) Applied Digital itself has disclosed B. Riley as a related party, and c) Chuck Hastings and Virginia Moore are extremely easy to challenge on an independence basis given their actions to date and their direct linkage to B. Riley and d) APLD paid down its loan prematurely to B. Riley to help B. Riley raise cash for its FRG acquisition despite needing the cash for growth purposes, e) Chuck Hastings did not recuse himself from the sexual harassment investigation into Wes Cummins despite the very obvious conflicts of interest.
We have voiced our concerns to Marcum (and find it appalling that Marcum handles audits for both firms given that B. Riley is one of Marcum’s largest clients making it less likely that Marcum will exercise independent judgment with respect to its audit of Applied Digital) but are not holding our breath that they will take any action given Marcum’s history. However, with a new independent monitor in place it is possible Marcum decides to probe this issue further given it is playing out in public for all to see.