Justin Martin

A high-tech startup called Xethanol raised $34 million to produce millions of gallons of biofuel. Shareholders have filed suits saying the company is built on hype.

(FSB Magazine) — Christopher d’Arnaud-Taylor was on a roll. It was early 2006, and Xethanol, the New York City firm he had founded, said it was closing in on the Holy Grail of alternative energy. Taylor was telling investors and the press that Xethanol would use anything from wood chips to old pizza boxes to make a cheap, clean fuel to replace gasoline – a potentially huge market. With oil prices high, alternative energy had become a darling of investors, and the company was able to line up $34 million of funding, $4 million of it from the venerable investment bank Goldman Sachs.

During the first half of 2006, Xethanol’s stock climbed from $2.65 to a high of around $15, giving it a market cap of $245 million. Not bad for a fledgling business with estimated 2006 revenues of $11 million, which had yet to make a cent of profit.

Then came an article published in August 2006 on Sharesleuth.com, an investor Web site run by Mark Cuban, the Dallas billionaire, owner of the Mavericks NBA team and founder of several tech companies. The piece questioned Xethanol’s claims about its technology and also raised questions about the background and conduct of Taylor, then the firm’s CEO, and of some major Xethanol shareholders.

Cuban disclosed that he had shorted Xethanol’s stock – in effect betting that the price would drop. The share price did collapse and was trading at around $2 a share as this issue went to press. Xethanol cried foul, asserting that Cuban was trying to paint the company in the worst possible light and then profit when its stock tanked.

FSB was eager to sort this controversy out. We had written a short piece in our February 2006 issue that was cautiously optimistic about Xethanol’s prospects. At the same time, as a champion of small business, we wondered whether the company’s claim about Cuban’s short-selling campaign held any truth. Was Xethanol a little guy victimized by stock manipulation? After an extensive investigation, we have concluded that Cuban was indeed onto something. Clearly we should have been more skeptical in our initial story (“Fill ‘Er Up With Caramel,” February 2006).

According to scientists, stock analysts, former Xethanol board members, and competitors interviewed for this story, Xethanol exaggerated its experimental ethanol capabilities. The company’s repeated announcements that it was on the verge of producing large amounts of a new kind of fuel called cellulosic ethanol triggered a buying frenzy for its stock.

At the same time, some company insiders unloaded shares, profiting to the tune of millions of dollars. Taylor recently stepped down as CEO. Two Xethanol directors resigned, disturbed that the company kept hyping its ability to make biofuel. Each sent Xethanol a letter, later filed with the SEC, complaining about the company’s behavior.

The Xethanol saga has turned into a cautionary tale. Whether public or private, a small company puts itself at risk when it makes heady, hard-to-keep promises to its investors

A big idea

Urbane and charming, Taylor, 61, says he was born in Madras, India, the son of a British diplomat. According to his resumé, Taylor has “directed the strategy, operations, and financial affairs of companies in the U.S., Europe, Africa, the Middle East and Asia and managed the development and execution of corporate turnarounds and entrepreneurial ventures worldwide.” For early career experience, he lists executive posts with major corporations such as Northrop Grumman, Reed Elsevier and Unilever.

Taylor launched his latest venture in 2000, though its initial name – Freereal-Timequote.com – suggests that he wasn’t necessarily looking to go into the ethanol business. That company rapidly morphed into LondonManhattan.com, then Xethanol. In 2003, Taylor acquired a small ethanol plant in Hopkinton, Iowa. In 2004 he bought a second ethanol plant in Blairstown, Iowa, out of bankruptcy.

Xethanol went public on Feb. 2, 2005, via a reverse merger. For about $300,000, Xethanol bought a shell company called Zen Pottery Equipment, a moribund Colorado kiln maker. Xethanol then merged with Zen and was listed on the American Stock Exchange.

From the outset, Taylor cast his company as a front-runner in the race to produce ethanol from so-called cellulosic biomass. Translation: While ethanol is generally brewed from corn, entrepreneurs are trying to figure out how to make it more cheaply from waste products – paper pulp, wood chips, those old pizza boxes. Come up with a way to use ubiquitous material to make ethanol cheaply, and a limitless new energy source opens up, pushing down fuel prices, reining in pollution, cutting America’s reliance on the unstable Middle East and slowing global warming. You can have your SUV and a future too.

An overview of Xethanol’s operations and prospects, dated September 2005 and circulated to investors, described the company as a “biotechnology-based ethanol producer and a leader in the emerging waste-to-ethanol industry.”

In a fall 2005 interview with FSB, Taylor laid out big plans: His company intended to launch eight new plants in the coming year, mostly along the East Coast. By the end of 2006 those plants would have the capacity to generate around 100 million gallons of ethanol from waste (enough to fuel 137,000 cars for a year ). The dollars would just flow. “We’re waste-to-ethanol,” he crowed at the time. “Where there’s muck, there’s money.”

Xethanol’s share price exploded during the spring of 2006. Yet SEC filings suggest that it spent at least as much on consulting, investor relations and public relations during the first half of that year as it did on engineering services – this from a company supposedly in the race for a technological breakthrough.

The promise unravels

For a while public relations might have seemed a wise place for Xethanol to spend its money. Faced with a paucity of information (from analysts, say), investors in tiny, thinly traded companies often place considerable reliance on press releases. The company’s public relations firm issued a steady stream of Web-based communiqués touting Xethanol’s promising innovations.

Those announcements correlated with upticks in the share price. Between January and April, Xethanol’s stock shot up sevenfold. During the same period, SEC filings show that Taylor sold 125,000 shares (or about 8 percent of his holdings at the time), netting $1.3 million. Jeffrey Langberg, a director, sold 130,000 shares for $1.4 million. On the advice of his attorney, Taylor refused to comment on any allegation in this article. Langberg did not respond to phone calls from FSB.

Soon after the stock’s run-up, Sharesleuth.com published its exposé and brought the party to an abrupt halt. It painted Xethanol as nothing more than a conventional producer of corn-based ethanol. The Sharesleuth.com reporter also paid a surprise visit to the Hopkinton, Iowa, facility and found it locked, dark and lacking basic services such as water. Far from opening new factories, the company had shut down one of its two existing ones after a brief period of operation.

Robin Buller, Xethanol’s vice president of strategic development, insisted that his company had disclosed the status of the facility, which had been shuttered in the spring of 2005. The September 2005 business overview, however, is unequivocal on the subject: “We produce and sell ethanol at two plants in Iowa.”

“Obviously in the business presentation it’s incorrect,” admitted Buller. “It was a mistake.”

Moreover, Xethanol is not close to producing ethanol from anything but corn. Established players in the waste-to-ethanol race, such as Spanish giant Abengoa, DuPont, and a Canadian company called Iogen, each spend tens of millions a year for R&D. By contrast, Xethanol has spent $239,651 over the past two years. The bulk of the company’s R&D spending has gone to buy licenses for experimental processes developed in various university labs.

According to Robert Rapier, a chemical engineer at the energy giant ConocoPhillips, similar licenses are widely available and offer little if any competitive advantage. After all, it is still necessary to perfect the process, build a custom factory around it, then churn out huge quantities of ethanol.

“To make themselves look like a tech-oriented company, they’re obtaining licenses that anyone can acquire,” says Barry Borak, a Boston-based energy consultant with financial-services clients such as AIM Investments and Loomis Sayles. Thomas Endres, an operations executive at Xethanol, defends his company’s approach: “We’re a tech company aggressively pursuing a myriad of technologies.”

Making ethanol from waste isn’t easy. Iogen, generally considered the front-runner in the field, has been chasing the cellulosic dream for 30 years. Since 2004, the company says, it has produced more than 70,000 gallons of experimental ethanol at a $35 million demo plant on the outskirts of Ottawa. Even so, the company admits it is at least a few years away from commercial production (2009 is the target date).

For its part, Xethanol owns the U.S. license for a process developed by Foster Agblevor, an associate professor at Virginia Tech. He’s one of Xethanol’s competitive trump cards, highlighted in press releases and other company materials. But Agblevor readily admitted to producing only “a few liters at a time, not that much,” in a laboratory.

A shady cast

As for Sharesleuth’s claims about Taylor’s murky past, a number of Xethanol’s largest stakeholders, it turns out, are former Taylor business associates who have faced disciplinary action from either the SEC or the NASD. “The web of relationships is very incestuous and very disheartening,” says Ian Horowitz of the New York City research firm Soleil Securities Group, the lone analyst now following Xethanol.

“The paths of Taylor and these various associates have crossed many times in the past. Each time, they’re walking away with bags of money.”

In response, Xethanol officials maintain that Taylor’s past associations prove nothing. Says Xethanol spokesman Richard Wilson: “This is a country of laws, and the fact is that [Taylor] isn’t guilty of anything; he hasn’t been charged with anything.”

One longtime Taylor associate, William Scott Smith of Delray Beach, Fla., provided management services to Xethanol from 2001 through 2005. When Xethanol went public, filings showed that Smith owned 972,414 shares (7.3 percent of the company), making him the second-largest stakeholder, behind Taylor. This is the same William Scott Smith who in 1995 was charged by the SEC with setting up a Denver shell company called Melbourne Capital Corp. and defrauding investors out of $174,000. Smith settled the charges in 1995, paying $256,000. The SEC barred him from ever again serving as an officer or director of a public company. Smith did not respond to numerous attempts to contact him.

Taylor has been the subject of serious allegations more than once. In 1992 two of his former business partners sued him in federal court in Washington, D.C., charging that he had diverted $1 million in client fees from the trio’s investment-banking firm into a new company he set up. Taylor settled the case.

In 1998 he was sued again, this time for $120,000 plus damages by a doctor from Poughkeepsie, N.Y., who accused Taylor and three associates of “racketeering activity.” To help arrange financing for a medical-management company, the doctor says he paid $30,000 to a group that included Taylor. Even though no financing materialized, Taylor and his cohorts allegedly kept the fee. Once again, the case was settled for an undisclosed sum.

In August 2006, shortly after the Sharesleuth.com blog appeared, Taylor stepped down as CEO of Xethanol. The company says the move was part of a long-planned transition rooted in the need to replace a visionary founder with an operations-savvy top executive capable of scaling up the business. Taylor, however, had recently signed a three-year contract to be CEO. Taylor received as severance $100,000 and an extension on some of his Xethanol options. He was hired as a paid consultant and kept his seat on the board.

In the fall of 2006, shareholders began to file suits against Xethanol – eight at last count. The plaintiffs are seeking to recover the millions they lost as the stock plummeted. Milton Ariail, a Xethanol stockholder, filed the first lawsuit. He charged management with making false claims to artificially inflate the stock’s price during the spring of 2006, while cashing out its holdings. Ariail also accused Taylor of inflating his resumé, an allegation that had appeared earlier in the Sharesleuth.com piece.

“Taylor had fabricated his resumé and never worked at companies such as Northrop Grumman, Unilever and Reed Elsevier,” Ariail asserted in the complaint. The companies Taylor said he had worked for either couldn’t confirm his employment or refused to comment. Xethanol referred us to Taylor, who refused to comment on the issue.

Picking up the pieces

Besieged by shareholder suits and beset by allegations of fraud, Xethanol’s seven-member board met on Nov. 9, 2006. By all accounts, it was a tense meeting, thanks to the presence of David Ames, 57, an Alpharetta, Ga., resident, former adman and founder of a cable-box maker that netted him tens of millions in the late 1990s.

Ames, who had joined the board only a month earlier, arrived with a proposal: Xethanol should press forward in its bid to become an experimental-ethanol maker, skeptics be damned. The company has licenses, he argued, so just let the engineers tinker with them. Eventually Xethanol would make good on its promises. “When you put ten engineers in a room and ask them to get from A to Z, they’ll get there,” he told FSB.

A rival board faction insisted that it was time for Xethanol to settle for being a small maker of corn-brewed ethanol. Ames won. The board endorsed his vision by electing him the company’s new CEO by a vote of 4 to 3.

During the meeting one of the dissenters, Marc Oppenheimer, who was chairman of the audit committee, resigned. Interim CEO Bernstein followed later that day. Says Oppenheimer: “There’s one tried-and-true way to make ethanol. You make it out of corn. Promising to make it out of waste? Well, you shouldn’t promise what you can’t deliver.”

Five days after the board meeting, Xethanol completed the acquisition of a facility in Spring Hope, N.C. The plant cost $4 million, plus 1,197,000 Xethanol shares. Xethanol’s new acquisition is an old, shuttered fiberboard plant. It has been sitting idle since 1998, when International Paper closed it down, laying off 200 people.

Here’s how Xethanol describes the new facility in a press release: “We plan to reopen the facility in 2007 as a pilot plant to demonstrate the technical feasibility and economic viability of using wood chips as a cellulosic feedstock.”

So what exactly does that mean? “The first feedstock will be corn to get things up and running,” explains Xethanol’s Buller. When asked how that qualifies as a pilot plant for “cellulosic feedstock,” an exasperated Buller finally replied, “We at least – damn it! – are making ethanol.”

What does the future hold? CEO Ames says the complaints from former board members Oppenheimer and Bernstein are nothing more than “sour grapes.” The SEC will not comment on whether it has launched an investigation. Horowitz of Soleil Securities, the lone analyst covering the company, has a strong sell on the stock.

In the meantime, Xethanol just announced that it has formed a new alliance with a company in Florida, and that it plans to start making an experimental kind of ethanol next year – from orange peels.