Below is a presentation by Muddy Waters’ Carson Block on how he ended up an activist short seller, explored the dysfunctions of the capital markets, his framework approach to short selling and more. He spoke earlier this week at Cuny Baruch. For a great summary see this Business Insider’s article by Julia La Roche.

Also Carson spoke at the Value Investing Congress this week – see our notes from his presentation here.

 

Carson Block: How I Ended Up An Activist Short Seller

Everybody can “find” him or herself. Don’t kid yourself about who you are.

Life and Business Lessons Learned

  • Be intellectually diverse.
  • Never stop learning.
  • Aim for mistakes, learn how to manage risk.
  • Learned that to understand investing in businesses, work in – or start – one!
  • The most valuable skill of all in business (and life)…

What Disabused Me of Naiveté

  • RWY
  • ATMS
  • ACLN
  • 2000 – 2001
  • Seeing behind the masks of people on Wall St.
  • Final domino: the auditors and ONP.

Carson Block: Exploring The Dysfunctions Of The Capital Markets

Auditors – Not Protecting Investors

  • Represent the interests of their clients – the people who hire and pay them.
  • A profession that rewards failure.
  • A profession fighting against accountability.
  • Level 3 fair value accounting is problematic.
  • Audits are not “clean bills of health” – they do not detect fraud.
  • Key audit work done by juniors.

Sino-Forest’s Best Friend: E&Y

“…the majority of the accounts receivable arising from sales of standing timber are realized through instructing the debtors to settle the amounts payable on standing timber and other liabilities denominated in Renminbi.”

Translation

95%+ of company’s reported gross profit in 16 years of being public never went into the company’s bank accounts!!!

Management

  • Incentives are often short-term.
  • CEOs are largely charismatic.
  • The more successful the CEO, often the less willing to be held accountable.
  • Andrew Fastow (ENE) won CFO
  • Magazine Award for Excellence in 1999.

Speaking of Andrew Fastow

Ishmael from Moby Dick:

“But when a man suspects any wrong, it sometimes happens that if he be already involved in the matter, he insensibly strives to cover up his suspicions even from himself. And much this way it was with me. I said nothing and tried to think nothing.”

Boards

  • Symbiotic relationship with CEOs.
  • Insulated from negligence liability by BJR, insulated from other liability by D&O insurance.
  • Many directors view directorships as perquisites, not responsibilities.
  • “Independent” investigations often shambolic.

Lawyers – “No Evidence to Support…”

  • Represent the interests of their clients – the people who hire and pay them.
  • “Prestigious” law firms are a surprisingly effective fig leaf.
  • Great at writing indecipherable prose.
  • Attorney-Client privilege hides innumerable acts of corporate wrongdoing.
  • “[Fraud] lawyers are eternal.” – John Hempton

Lawyers – at their “Best” in China

  • At least 9 painful exonerations of N. American-listed China companies.
  • NQ – one concession from Shearman & Sterling: “Despite the Investigation Team’s extensive review of documents and data provided by sources both within and outside the Company, the Investigation Team could not verify that the devices it collected and copied contained all responsive informationat the time the copies were made. On many devices, the Investigation Team observed indications that some information might be missing, and the Company’s management and staff were unable to provide a credible explanation for what the Investigation Team observed.”

Market Research Firms – Giving Legitimacy

  • Sino-Forest & Jaakko Pöyry
  • Frost & Sullivan

– NQ Mobile Inc (ADR) (NYSE:NQ)

– Tianhe Chemicals Group Ltd (HKG:1619)

  • iResearch & other examples from China

China & VIEs

  • China is to stock fraud as Silicon Valley is to Technology.
  • Investors have become complacent once again about the risks.
  • No fraudster from China has ever been meaningfully punished for defrauding N. American investors.

Carson Block China & VIE

Carson Block: Muddy Waters 101 by ValueWalk