Carson Block defended the practice of short selling on Wednesday and told CNBC it provides a crucial role in protecting investors by identifying companies that could mislead investors.
“I got into this business 11 years ago helping eliminate various frauds from China that figured in the U.S.,” said Muddy Waters Research founder, “Squawk Box”. “We have, globally, eight corporate layoffs and two other regulatory actions that have led to sanctions. That seems pretty American to me when we’re protecting investors.”
Block has been a short seller with close watch since he bet on Sino-Forest, which was finally withdrawn from the Toronto Stock Exchange in 2012, following the 2011 report by Muddy Waters. He accused the Chinese firm of fraudulent wood. In 2018, plaintiffs in a civil case against Allen Chan, co-founder and CEO of Sino-Forest, received billions of dollars in damages.
Last week, Block unveiled its latest short position, accusing XL Fleet of exaggerating its sales to justify future revenue projections.
XL Fleet, which manufactures electrification action systems to convert traditional commercial and municipal vehicles into hybrids, strongly rejected Muddy Waters ’allegations in a statement Monday. Boston-based XL Fleet said the short-term sales report “contains numerous factual inaccuracies, misleading statements and erroneous conclusions.”
The practice of short-term selling, essentially a bet on falling stocks, has come under scrutiny following the short-term reduction of GameStop that began in January to January on Reddit. The shares of the video game retailer had a massive short interest rate, which some retail investors realized and began buying GameStop shares and call options that helped drive up the price.
Short-term sellers borrow one-share shares and resell them on the market, with the goal of repurchasing them at a lower price. They then return the shares lent and reap the benefits of the difference. When the opposite happens, as with GameStop, shorts can try to recoup stocks at current higher prices to limit their financial losses.
Hedge funds like Melvin Capital, which caused a short circuit at GameStop, believed the company’s value would continue to decline as the brick retailer faced e-commerce and more players engaged in digital downloads instead. to Buy the Physical Disk | Melvin founder Gabe Plotkin explained the company’s reasoning for triggering the GameStop short circuit at a congressional hearing in February.
Block’s Muddy Waters chooses his short targets differently, often betting on companies he believes are misleading investors, rather than just having a languid business in secular decline.
Another Muddy Waters company bet against it was Luckin Coffee, which announced a short earlier last year, believing the Chinese firm was committing fraud. An internal investigation by Luckin Coffee subsequently determined that its chief operating officer manufactured the sales and the shares were eventually withdrawn from the Nasdaq months later.
Block, like all short sellers, has financial incentives for their target stocks to fall and public disclosures of their company’s positions are known to move stock prices, even if it may be only temporary. That’s why there are those who criticize people like Block for going on TV, for example, to discuss their company’s bearish bets.
Asked directly by Andrew Ross Sorkin of CNBC about those who want to impose restrictions on short-term sales or argue that Block’s public campaigns against companies “are not the American way,” he retorted.
“The other side of this is that, in my perspective, you’re saying right,‘ Cheating, swindling, exaggerating and making money for this is the American way, ’” Block said, reiterating that “if we’re trying to expose and eliminate economic incentives for a small number of people to take advantage of naivety, that’s American. “
GameStop’s volatile action and the role social media played in attracting retail investors to a strong stock bet has raised questions about how short sellers will approach positions in the future. Plotkin, for example, told Congress he believes hedge funds will adapt their strategies to prevent them from getting caught up again in these dramatic pressures.
One company, Citron Research, has already said it is moving away from publishing short-selling research in favor of looking for long positions.
While Block said he believes GameStop may have changed the dynamics in some way, he said he first noticed a noticeable change last year. A company Muddy Waters tested a short circuit “it ripped us off and that was new,” Block said.
“This told us that there are a lot of things on the market that have nothing to do with fundamentals and that are really technical,” he said. “Coming this year before GameStop, we were thinking a lot about flows and passivity [management] and ETFs really distort markets, so when we saw GameStop, I think it’s just the five-alarm fire that says these markets are really separate from the fundamentals of the underlying asset. “