Carson Block reveals Muddy Waters' secret weapon: the SEC

Muddy Waters' Carson Block says he uses information from the public website of SEC to make short-selling calls on Chinese stocks

PUBLISHED : Thursday, 21 February, 2013, 12:00am
UPDATED : Thursday, 21 February, 2013, 6:07am


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Muddy Waters, whose analyst reports triggered US$7 billion in losses for mainland Chinese stocks, used an unlikely secret weapon for its research: the public website of the United States Securities and Exchange Commission.

Carson Block, the short seller who heads Muddy Waters, said he was an avid reader of letters from the SEC's corporation- finance experts to executives about the adequacy of disclosures in regulatory filings.

"The CorpFin accountants do a good job of spotting issues in the companies' filings," said Block, a co-author of Doing Business in China for Dummies.

"We've read some astute questions from CorpFin on a range of issues."

Informed by such correspondence, the research firm's 2010 report on Chinese waste treatment company Rino International helped drive that firm's stock from US$13 to almost zero, erasing about US$370 million in market value. It was not a fluke.

Block, a lawyer, gained fame for his short-selling calls on Chinese stocks after regulators halted trading in four of his first five targets, starting in June 2010.

He founded Muddy Waters in 2010 in Shanghai but moved the company to Los Angeles later, saying Chinese officials were harassing his analysts.

The SEC, set up in 1934 to lift confidence in securities markets during the Depression, reviews 4,000 companies a year with special attention to new filers and industries in the spotlight, from Facebook to big banks.

SEC letters and company responses are not posted to the regulator's website until a month after they are sent, receiving no fanfare to alert interested investors. As a result of the correspondence, the agency often forces companies to amend or make additional disclosures to inform investors of material risks.

Some investors spot the required amendments to annual reports or registration statements. What is missed by many is the detailed discussion of shortcomings in a company's business that can warrant a bet against the stock.

Take the backstory about Rino in its correspondence with the SEC.

As early as 2007, the agency quizzed Rino over the departure of its accountant, saying it must disclose any disputes with professionals in its filings. Rino at first insisted there were none.

The SEC pushed back, telling the company that investors must be told if an auditor expressed "uncertainty regarding the ability to continue as a going concern".

Rino amended a filing to say there were no disagreements over financial statements - "except" that the auditor doubted the company was viable.

Four years later, the SEC stopped trading of Rino because it did not tell investors that investigators hired to probe fraud allegations had also left.

By then, Rino had fallen from US$34, briefly becoming the Nasdaq's top short-seller target. Block piled on with his November 10, 2010, report.

That report finally caught the attention of Rino holders who had missed or ignored accounting-violations clues in SEC letters, perhaps dazzled by the lure of riches to be made by investing in a booming China.

Investment advisers were touting China's gross domestic product, which the World Bank said rose 10.4 per cent in 2010 and 9.2 per cent in 2011.

That growth helped drive up the price of PetroChina enough for it to pass Exxon Mobil as the world's most valuable company by market capitalisation in 2009.

Roth Capital Partners, a US investment bank with an office in Hong Kong that has been bullish on Chinese stocks, said in 2010 mainland China's growth would outpace other economies "for the foreseeable future", boosting the country's US-listed stocks.

While Block was getting started with his research, China fans clung to shares such as Sino-Forest, now bankrupt, and New Oriental Education & Technology was investigated by the SEC and staved off a stock collapse until last year, perhaps because investors did not do their SEC homework, said Peter Henning, a former SEC lawyer.

"That's the obligation of every investor," Henning said. "A company amends its filings because information is already out in the market that needs to be corrected or updated."

Chinese companies in recent years were the object of at least 19 lawsuits and other enforcement actions targeting 64 defendants in all, according to SEC data.