Wall Street Getting First Word Not New as Sino-Forest Falls

Muddy Waters Research Founder Carson Block
Carson Block, founder of Muddy Waters Research. Source: Bloomberg Televison via Bloomberg

The assertion that a short seller offered to sell market-moving research to other traders before making it public is failing to sway investors after the biggest plunge in the history of Sino-Forest Corp.

Carson Block, whose analysis of Sino-Forest was published before the shares lost 72 percent in Canadian trading, made the offer to investors before releasing the report on his website, according to Dundee Securities Ltd. analyst Richard Kelertas, who didn’t say how he got the information. Block, founder of Muddy Waters Research, declined to comment.

Scrutiny of the people who are betting against Chinese companies is increasing after short interest in the shares reached a record. Lawyers, analysts and investors said selling the research is usually legal and while the practice may hint at manipulation, it’s also a sign an analyst is confident enough to make himself accountable to others.

“You have to recognize that firms like Muddy Waters aren’t doing this research as a public service,” said Paul Hickey, co-founder of Bespoke Investment Group, a Harrison, New York-based research firm. “As long as they didn’t have any inside knowledge, it wouldn’t appear that they did anything wrong. While it seems like a sleazy move at first glance, in principle it’s no different than what most any other firms do.”

Probably Short

Block, 35, says in reports on his website that he has clients and that his analytical services are available “on an engagement basis.” The firm’s members, employees and consultants are probably short stocks mentioned in his research, according to a disclaimer in his reports. He declined to say who receives his services or how much money he stands to make from any investment or report.

“It has been a consistent policy since day one that Muddy Waters does not comment on its revenue model beyond the contents of the disclaimer it places on the cover page of its reports,” he wrote in an e-mailed on June 8. His firm isn’t registered under Canadian securities law.

The June 2 analysis said public disclosures by Sino-Forest, a tree plantations operator based in Hong Kong and Mississauga, Ontario, don’t match Chinese city records and that its production figures may not be accurate. The stock fell to C$5.23 from C$18.21 in the two days after the statements were publicized.

“The allegations contained in this report are inaccurate and unfounded,” Allen Chan, Sino-Forest’s chief executive officer, said in a statement. “Muddy Waters’ shock-jock approach is transparently self-interested and we look forward to providing our investors and other stakeholders with additional information to rebut these allegations.”

Timber Holdings

RBC Capital Markets analysts said today that the company has more extensive timber holdings than claimed in the Muddy Waters report and may not have been subject to harvest limits alluded to in the document. Analysts Paul Quinn and Hamir Patel maintained an “outperform” rating on the stock in a note.

Kelertas, the Montreal-based analyst for Dundee who had rated the stock a “buy,” said in a June 7 conference call that the Muddy Waters report is inaccurate and there’s nothing fraudulent about Sino-Forest. Dundee helped Sino-Forest raise money in a stock offering as recently as December 2009, and Kelertas recommended buying the shares from September 2007 until June 3, when he put his rating under review. He didn’t return phone and e-mail messages seeking comment yesterday.

“I can’t say whether the way Block is doing this thing is kosher or not, but it seems to me that he has thought a lot about this,” said Steven Persky of Dalton Investments LLC, a Los Angeles-based fund with $1.3 billion in assets. “He states up front that they have a short position, so you know what their bias is, but it also looks like he has done a massive amount of research and has enormous conviction.”

Record Shorting

Short selling, the sale of borrowed shares with the hope of profiting when they fall, more than doubled to a record 35 percent of Sino-Forest’s outstanding stock as of June 2, according to Data Explorers, a New York-based research firm. The figure started climbing four weeks earlier, from 17 percent on May 2. Sino-Forest is the most-shorted stock in the Standard & Poor’s/TSX Composite Index.

Sino-Forest shares dropped 21 percent to C$14.46 on June 2, the day the Muddy Waters report came out. They had traded at an average of C$22.32 in 2011, Bloomberg data show. The stock plunged 64 percent on June 3 as the company said it would establish a committee of independent directors to examine the accusations. Since the report, the company has lost C$3.21 billion ($3.3 billion) in market value, and the shares are trading near the lowest level since 2006.

Five Stocks Targeted

They slipped 13 percent to C$4.50 at 4:36 p.m. in Toronto.

Muddy Waters has published analyses of five companies since Block started releasing reports last year. Each has declined, wiping out almost $4.5 billion in market value through yesterday, according to data compiled by Bloomberg.

Block’s firm said on Feb. 3 that it was betting against China MediaExpress Holdings Inc., a provider of advertising on buses in China whose stock has since been delisted from the Nasdaq Stock Market. By the day before he released the report, short interest on the Hong Kong-based company had more than tripled to 11 percent of outstanding shares, from 3.6 percent at the beginning of December, according to Data Explorers. Short interest didn’t rise before Block analyzed the three other companies.

Short interest on the Bloomberg Chinese Reverse Mergers Index of U.S.-listed stocks rose to a record 6.3 percent of shares outstanding on May 17, according to data going back to January 2010. Bearish bets against the index were at 5.8 percent as of June 7, up from 3.4 percent at the end 2010.

Raising Questions

Block’s combination of selling research and investing in the stocks he reports on before publicizing his stance raises questions about his motivation, said Timothy Ghriskey, chief investment officer at Solaris Asset Management, which manages $2 billion.

“There are definitely reports out there from all sorts of firms trying to gain a leg up by doing things like this,” said Bedford Hills, New York-based Ghriskey. “I would hope that that kind of marketing wouldn’t be permitted.”

Muddy Waters could conceivably face regulatory review under rules designed to protect investors from harm, according to Philip Anisman, a Toronto-based securities lawyer. Anisman has been an attorney for more than three decades and helped draft insider-trading legislation.

“There’s an issue that could be raised as to whether a securities professional who intends to make the information public and pre-sells it is acting inconsistent with the public interest,” he said. “Securities commissions in Canada have a general discretion to discipline market participants when they act contrary to the public interest, to bar them from trading. It’s not necessarily based on a violation of law.”

No Office

Block, who says he doesn’t keep a permanent office, is “an entrepreneur who’s practiced law and pioneered an industry in China,” according to the Muddy Waters website. The company specializes in what it says are under-researched Chinese companies and is “available to work with institutional investors on an engagement basis,” the website says.

Block said he passed his broker’s license exam at 19 and received a degree in business administration from the University of Southern California in 1998. He went on to attend Chicago-Kent College of Law and ended up founding Love Box Self Storage in Shanghai.

“There are plenty of research firms out there that their business model is to sell the material to the highest bidder first and then roll out, shall we say, delayed quotes to other people,” said James Angel, a professor at Georgetown University in Washington. “These guys seem like classic short sellers in that they do their research, they make their bets, and once they’ve made them, they trumpet them far and wide.”

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