Document Security Systems (AMEX:DMC) recently announced a new credit arrangement that has many investors and activist groups questioning the motives of the company’s management and board. A recent proxy statement by the company revealed a $3 million loan inked with Fagenson & Co’s Robert Fagenson, who owns 7.4% of the company and also happens to be on the board of directors.

Despite DMC’s $88 million market cap with no outstanding debt, the company decided to forego traditional financing and instead take a loan from its largest shareholder. Interestingly, the loan was collateralized with DMC’s largest subsidiary, Plastic Printing Professionals Inc., which is also the company’s only profitable division producing a product. Asensio and other large activist groups and shareholders have since questioned the motives behind such arrangements.

The arrangement will allow Fagenson to either profit from DMC’s rise or become the new owner of Plastic Printing Professionals if the loan doesn’t get paid back – either way, he’s a winner. However, the outlook is not so great for DMC’s other shareholders who stand to lose the most profitable division of their company with financing that was unnecessarily collateralized when alternative financing was available… they will be forced into court in order to recover any money they lose.

So, is Robert Fagenson setting himself up to obtain the company’s most valuable asset by using it as collateral for a small $3 million loan that could have easily been obtained elsewhere? Well, even the possibility of such a disastrous move should be enough to frighten some shareholders. DMC is also involved in some questionable dealings – the firm is currently engaged in a stock-financed legal battle against the European Central Bank over its patented anti-counterfeiting technology. The move comes after the company tried to sue the U.S. Treasury Department for infringements when the new $100 bill was release (which was rejected).

In the end, investors may want to stay away from this company while its most valuable asset is put at risk for a small $3 million loan. A loss of this division would be devastating while shareholders continue to face significant dilution as a result of frivolous lawsuits against central banks. While a court victory would almost certainly provide a massive boost to the share price, it is a probability that seems minute at this point.

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