Short sellers are often the only sheriff on Wall Street, a crucial role in a defrauded stock market – easy to forget after the furor over “best-selling stocks”.
By Wolf Richter for WOLF STREET.
Luckin Coffee, a copycat for Starbucks and one of many Chinese companies with no US operations that have their IPOs in the U.S. and raise funds in the U.S., filed for Chapter 15 bankruptcy in New York today. Luckin’s downfall was triggered by short seller Carson Block of Muddy Waters, who published detailed allegations on January 31, 2020, of massive fraud at the company, perpetrated at the highest levels.
When the Muddy Waters report was published, the company’s stock – well, American Depositary Receipt (ADR) – skyrocketed from the IPO price from $ 17 per share in May 2019 to $ 50 per share in January 2020, giving the company a market capitalization (share price times outstanding shares) of $ 12.6 billion.
The short seller’s report caused the stock to plummet. On April 2, 2020, the company finally admitted that it had made $ 310 million (RMB 2.2 billion) in revenue for 2019, almost doubling its actual revenue. He said that “as of the second quarter of 2019, Mr. Jian Liu, the director of operations and a director of the Company, and several employees reporting to him, have been involved in certain misconduct, including the manufacture of certain transactions.”
The fraud, perpetrated in China, was designed to raise the price of shares in the US, and it worked, being fundamental to a gain of almost 200% of shares in eight months.
On the day the company admitted false revenue, shares plunged 82% more. In the days that followed, stocks fell further. Then, the negotiation was stopped. Eventually, Nasdaq withdrew the ADR.
The claims of short sellers, which forced the company to admit at least part of its irregularities, finally woke up the SEC, whose role is to protect investors from this type of thing, but is dormant most of the time. As long as stocks are rising, there is nothing to protect. It is only after they collapse that the SEC wakes up.
Thus, the SEC began to eavesdrop and, on December 16, 2020, announced that it had accused Luckin of “defrauding investors by incorrectly disclosing the company’s net income, expenses and operating loss in an effort to pretend it was achieving rapid growth and greater profitability to meet the company’s earnings estimates. ”
The details of the charges confirmed the short seller’s claims. But without the short seller, there would have been no SEC charges. And the fraud would have continued and expanded. And Wall Street would be on board, happily making money from it.
In a pre-established agreement, the SEC also announced in the same breath that Luckin had agreed to settle the charges by paying a $ 180 million fine.
Carson Block did not do the research on Luckin himself. Another person did the legwork and put together a detailed 89-page report and sent it to several well-known short sellers in the United States. Block took over his short positions and released the report. The other short sellers who received the report did not adhere to it.
Block, in an interview last June, told the Wall Street Journal that it was the first time he published someone else’s research to support his short position.
“It was nothing glorious that we did here. We just felt confident that the report was directionally correct, so we decided that we would be a good platform for that, ”he said. He also said he had known the report’s author for several years, but declined to reveal the author’s identity.
So now Luckin has filed for Chapter 15 bankruptcy in New York. In China, Luckin’s stores would remain open, he said in the press release, and operations would continue as normal.
But American investors who believed in the Wall Street hype and the company’s statements before and after the IPO, and who financed the company in the IPO, or bought the shares after the IPO, got screwed.
Credit Suisse, Morgan Stanley, Chinese investment bank CICC and Haitong International were joint brokers in the IPO of this fraudulent company. And Wall Street analysts, including an analyst at bookrunner Morgan Stanley, hailed the stock.
On June 11, 2019, a few weeks after the IPO, Barron’s came out publicizing the shares and citing three analysts who had started covering ADR that day, all with price targets much higher than the price of the time. One of those analysts was Morgan Stanley’s Lillian Lou.
Can investors expect real Wall Street analysis when Wall Street makes so much money from these investors’ entry and exit fees?
No. All they will get will be lies and exaggerations that generate fees.
Nor will the SEC protect investors. If it goes into action, it will be late and after the collapse.
In such cases, a short seller is the only sheriff left on Wall Street. Everyone hates them. They take huge risks and can easily be run over by a small, organized squeeze. And they are not paid by taxpayers; they are paid out of the gains from their short positions, unless they are crushed.
In the furor over the superbly designed historic squeeze of “best-selling stocks”, including GameStop and AMC, when the social media crowd vilified short sellers and made them their target, it’s easy to forget the essential role short sellers play in a manipulated market.
This short-term historical squeeze, devised by a group of deeply cynical small traders, exposed how manipulated the market was. Read… The stock market is broken, now for everyone to see
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