Making Money Shorting US Listed Chinese Frauds
I’ve seen two reports so far from them and they both turned out to be bang on.
Unfortunately for me, I didn’t take a position in either company. But in preparation for the next report from Muddy Waters I’d like to learn more about them so that I can decide whether I should be willing to act on their advice.
Here is a recent interview that the founder of Muddy Waters did with Barron’s:
Carson Block has spent the past five years seeking his fortune in China. With some Mandarin under his belt, he practiced law for a year, conducted research for hedge funds and for his father, a U.S. investor, and even started a self-storage venture. But Block, 34, seems to have hit his stride with Muddy Waters Research, an online service he launched in June 2010 to expose what he describes as misstatements and fraud at small Chinese companies trading in the U.S.
Beware This Chinese Export," Aug. 30, 2010), and the Securities and Exchange Commission now is investigating possible abuses in this market.
Orient Paper (ONP) had overstated revenue and misappropriated funds, investors lambasted his tactics and credibility, and the company disputed his findings. Undaunted, he has since issued negative reports on two more Chinese companies.
Investors who sold shares of these companies short after each report was published have reaped double-digit returns. RINO International (RINO), the subject of Block's second report, has admitted to some of the irregularities Muddy Waters cited. Its stock was delisted last fall.
During a recent visit to New York, Block met with Barron's to discuss his recommendations and the outlook for the reverse-merger market.
Barron's : In a sentence, what do you do?
Block: I am exposing what I believe are substantial frauds before they suck up more money from investors.
Why did you decide to work in China, and eventually focus on Chinese reverse-merger stocks?
At the outset of law school, I didn't think I would practice for one day. I ended up enjoying law school so much that I decided it would make me a better business person, a better entrepreneur. After law school in 2005, I went to China because I figured it would offer me more entrepreneurial opportunities. I chose Shanghai because I thought the post-legal opportunities would be better. I came across a stock that was a substantial fraud. It happened to be a reverse merger, and that is how the whole Muddy Waters saga started.
How do you define fraud?
I am exposing companies in which less than 50% of their claimed revenue actually exists. That is well beyond the realm of mistake. Fraud is a willful, material deception [entered into] for the sake of a theft. This is not just aggressive accounting. If a company is doing $100 million a year in revenue, claiming it is a manufacturer but in actuality is outsourcing production, that's also a form of fraud. And that may indicate profit margins may be different than what the company is claiming.
What we are talking about here is egregiously incorrect statements about the business, like multiplying the revenue by a factor of two or more in order to raise money from shareholders, much of which will somehow be stolen by management. Or, in certain cases, the fraud will support artificially inflated stock prices that management will take advantage of in selling their stock.
Here is the rest of the article: