Carson Block defended the practice of short-selling on Wednesday, telling CNBC that it plays a critical role in protecting investors by identifying companies that could be misleading investors.
“I got into this business 11 years ago by helping to eliminate some of the fraudsters from China who are in the US,” said the founder of Muddy Waters Research “Squawk Box.” “We have eight corporate removals worldwide and two other regulatory measures that have resulted in sanctions. That seems pretty American to me when we protect investors.”
Block has been a closely watched short seller since betting against Sino-Forest, which was eventually banned from the Toronto Stock Exchange in 2012, in the wake of the 2011 Muddy Waters report, accusing the Chinese lumber firm of fraud. In 2018, plaintiffs were awarded billions of dollars in damages in a civil suit against Allen Chan, co-founder and CEO of Sino-Forest.
Last week, Block published his latest short position, accusing XL Fleet of exaggerating its sales pipeline to justify future earnings forecasts.
XL Fleet, which makes electric propulsion systems to convert traditional commercial and municipal vehicles into hybrids, vehemently rejected the allegations made by Muddy Waters in a statement Monday. Boston-based XL Fleet said the short selling report “contains numerous factual inaccuracies, misleading statements and false conclusions.”
The practice of short selling – essentially a bet that a stock will fall – has come under scrutiny in the wake of the Reddit-fueled GameStop short squeeze that began in January. The video game retailer’s stock was at tremendous short-term interest, which some retail investors realized and started buying GameStop stock and call options that helped move the price up.
Short sellers borrow shares of a stock and then sell them back in the market, with the aim of buying them back later at a lower price. Then they return the borrowed shares and take advantage of the difference. When the opposite happens, as with GameStop, shorts can try to buy back the stock at current higher prices to limit their financial losses.
Hedge funds like Melvin Capital short-circuiting GameStop believed the company’s value would continue to decline as the brick-and-mortar retailer fought a shift to e-commerce and more gamers turned to digital downloads instead of buying the physical disc. Melvin founder Gabe Plotkin explained the company’s reason for shorting GameStop in a hearing at Congress in February.
Block’s Muddy Waters chooses its short targets differently, often betting against companies it thinks are misleading investors, rather than just running a languishing company in secular decline.
Another company Muddy Waters bet against was Luckin Coffee – who announced a short early last year, believing the Chinese company was committing fraud. An internal investigation by Luckin Coffee later determined that the chief operating officer fabricated the sale, and the stock was eventually dropped from the Nasdaq months later.
Block, like all short sellers, has financial incentives to drop his target stocks and his company’s public disclosures of positions are known to affect stock prices, even if only temporarily. That’s why some people criticize people like Block for going on television to discuss his company’s bearish bets, for example.
Asked directly by CNBC’s Andrew Ross Sorkin about those seeking to restrict short selling or claim that Block’s public campaigns against companies are “not the American way,” Block pushed back.
“The other side of that is, my perspective is that you’re basically saying, ‘Cheating, scamming, overdoing it, and getting money for it is the American way,’ Block said, repeating that ‘if we try to get out of there. To expose and remove incentives for a small number of people to take advantage of naivety, that’s American. “
The fleeting action in GameStop and the role social media played in attracting private investors to the strongly opposed stocks have raised questions about how short sellers will approach positions in the future. For example, Plotkin told Congress that he believes hedge funds will adjust their strategies to avoid getting into such dramatically short periods again.
One company, Citron Research, has already said it is moving away from publishing short selling research looking for long positions.
While Block said he thinks GameStop has somehow changed the dynamics, he said he first noticed a noticeable change last year. A company that shorted Muddy Waters “ripped us off, and that was new,” Block said.
“That told us there’s a lot going on in the market that has nothing to do with fundamentals, and it’s really technical,” he said. “When we came before GameStop this year, we thought a lot about flows and how passive [management] and ETFs really warp the markets, so when we saw GameStop, I think that’s just the five-alarm signal saying that in many cases these markets are really separate from the fundamentals of the underlying asset. “