Carson Block defended the practice of short selling on Wednesday, telling CNBC that it plays a crucial role in protecting investors by identifying companies that could mislead investors.
“We entered this business 11 years ago, helping to eliminate several frauds in China that were listed in the United States,” said Muddy Waters Research founder Squawk Box. “We have, globally, eight company write-offs and two other regulatory actions that have led to sanctions. That seems pretty American to me when we protect investors there.”
Block has been a short-sighted seller since he bet against Sino-Forest, which was finally deregistered from the Toronto Stock Exchange in 2012, following the 2011 Muddy Waters report. He accused the Chinese company of fraud timber. In 2018, the plaintiffs in a civil lawsuit against Allen Chan, co-founder and CEO of Sino-Forest, received billions of dollars in damages.
Last week, Block released its latest short position, accusing XL Fleet of exaggerating its sales pipeline to justify future revenue projections.
XL Fleet, which produces electrification drive systems to convert traditional commercial and municipal vehicles to hybrids, denied the allegations at Muddy Waters on Monday in a statement. Boston-based XL Fleet said the short sales report “contains numerous factual inaccuracies, misleading statements and erroneous conclusions.”
The practice of short selling – in essence, a bet that a stock will fall – was brought under control following the short reduction of the GameDop, which began in January. The shares of the video game retailer had a massive short interest, which some retail investors realized and began to buy GameStop shares and call options that contributed to the price increase.
Short sellers borrow shares of a stock and then resell them on the market, in order to buy them later at a lower price. Then, return the borrowed shares and take advantage of the difference. When the opposite happens, as in the case of GameStop, shorts can try to buy stocks at higher current prices to limit their financial losses.
Hedge funds, such as Melvin Capital, which shortened GameStop, believed the company’s value would continue to decline as the brick retailer struggled with a shift to e-commerce and more players turned to digital downloads instead of buying physical disk. Melvin’s founder, Gabe Plotkin, explained the company’s rationale for short-circuiting the GameStop at a congressional meeting 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 relentlessly declining business.
Another Muddy Waters company bet against was Luckin Coffee – announcing a short at the beginning of last year, believing that the Chinese company is committing fraud. An internal investigation by Luckin Coffee later determined that its chief operating officer had made sales, and the stock was eventually deregistered from the Nasdaq months later.
Block, like all missing sellers, has financial incentives to reduce its target shares, and public disclosures of its company’s positions know that they will move stock prices, even if they may be only temporary. Because of this, some people criticize people like Block for going on television, for example, to discuss his company’s bearish bets.
Asked directly by CNBC’s Andrew Ross Sorkin about those who want to restrict short sales or claim that Block’s public campaigns against companies “are not the American way,” Block declined.
“The other side is that, my perspective is that you’re actually saying right then, ‘Cheating, scamming, exaggerating and making money for this is the American way,'” Block said, reiterating that “if we try to expose and eliminate economic incentives there for for a small number of people to take advantage of naivety, that’s American. “
The volatile action in GameStop and the role that social media has played in attracting retail investors to high-stakes stocks have raised questions about how short sellers will approach positions in the future. Plotkin, for example, told Congress he believes hedge funds will adjust their strategies to avoid being caught up again in such dramatic leaks.
One company, Citron Research, has already said it is moving away from publishing short-selling research in favor of looking for long positions.
Although Block said he believed GameStop could have changed the momentum in some respects, he said he first noticed a visible change last year. A Muddy Waters company short-circuited “it ripped us off and that was new,” Block said.
“That told us that there is a lot going on in the market that has nothing to do with the fundamentals and is really technical,” he said. “Coming this year before GameStop, we thought a lot about flows and how passive [management] and ETFs are really distorting markets, so when I saw GameStop, I think it’s just the five-alarm fire that says these markets are really divorced, in many cases, from the fundamentals of the underlying asset. “