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  • Apr 21, 2014
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RESEARCH

Carson Block fishes for clarity in China's muddy business waters

Short-seller learned about business on the mainland the hard way and aims to keep digging into its firms to protect investors

PUBLISHED : Monday, 20 August, 2012, 12:00am
UPDATED : Monday, 20 August, 2012, 4:51am

Carson Block, founder of Muddy Waters Research, parlayed his short-selling research reports into a reputation as an expert in the detailed inner workings of China's corporate world.

But the 36-year-old modestly describes himself as being only a "big-picture guy" who looked into China's problems and couldn't help but spot the dodgy dealers and their frauds.

"China is a low-trust environment," Block told the South China Morning Post. "My observation is that if you take a look at any organisation or society, it's the top that is corrupt. Corruption flows from the government."

Muddy Waters got its name from an old Chinese proverb that says: muddy waters make it easy to catch fish. But in modern China the muddy waters refer rather to loopholes in the regulatory system that make it easy for sharp operators to chase easy profits.

Block said he aimed to help Western investors better understand the Chinese corporate culture and the mentality of entrepreneurs.

Evolving from a one-man research outfit, Muddy Waters rose to global prominence in mid-2010 when it began publishing reports accusing overseas-listed Chinese companies of fraud - accusations that caused share prices to plummet.

But Block, a native of New Jersey, belied the image of a brash corporate basher, talking in a confident but mild manner about his exploits.

He graduated from the University of South California in 1998 before moving to Shanghai, where he planned to set up an equity research firm focusing on mainland-listed A shares. But he aborted that plan because the local market wasn't ready for research - trading instead on rumours.

Block returned to the US and worked for his father's equity research business WAB Capital.

He then did a degree at the Chicago-Kent College of Law and in 2005 returned to Shanghai and worked at the Jones Day law firm before quitting at the end of 2006.

He planned to set up a private banking business in Singapore but ended up establishing a self-storage company Love Box in Shanghai in 2008. That was an important experience because the day-to-day operations helped turn his knowledge of China from "theoretical to actual".

"Through the process of doing transactions I began learning hard lessons," he added. "I began to really understand the mentality of Chinese business people."

Piggybacking on the nation's opening-up policies and its rapid economic growth, a swarm of Chinese people ventured into privately owned businesses, hoping to get rich overnight by taking advantage of regulatory loopholes. Tax evasion, fake products and fraudulent business deals were viewed as common practices by Chinese entrepreneurs.

"They do not try to do branding," observed Block, who is also a co-author of Doing Business in China for Dummies.

"They have not yet gone through learning process."

Astute in finding problems that face the Chinese economy and the business environment, Block did not seem comfortable with his celebrity status, saying just that Muddy Waters would continue to try its best to "do all the digging" to help protect investors.

Chinese firms targeted by Muddy Waters include Focus Media, a digital media and advertising company; New Oriental Education and Technology, an education group, Orient Paper and Sino-Forest, a timber business. Shares of all the companies dived following the publication of Muddy Waters' reports.

Asked how long it would take for Chinese companies to improve corporate governance, Block said with some hesitation: "It might be a while."

He wasn't entirely downbeat about China, however, admitting there were many people with integrity.

"But it is because they have integrity that they are not able to rise to the top," he said.

Block also lambasted the VIE (variable interest entity) structure used by Chinese firms to effectively list their assets in North America, strongly advocating reform to avert accounting frauds.

Under a VIE structure, Chinese firms and their investors set up an offshore vehicle, which, through one or more foreign investment subsidiaries in China, enters into contracts with the operating firms in China.

The contracts enable the offshore vehicles that are eventually listed overseas to retain control of the mainland operating companies.

"The best thing will be, of course, direct ownership by foreign shareholders of the operating companies," Block said.

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