Carson Block defended the short selling practice on Wednesday, telling CNBC that it plays a crucial role in protecting investors, identifying companies that can deceive investors.
“I entered this business 11 years ago helping to eliminate a series of frauds from China that were listed in the United States,” Muddy Waters Research founder told Squawk Box. “We have, globally, eight withdrawals from companies and two other regulatory actions that have led to sanctions. That seems very American to me when we are out there protecting investors.”
Block has been a closely watched short seller since he bet against Sino-Forest, which ended up being pulled from the Toronto Stock Exchange in 2012, following Muddy Waters’ 2011 report. He accused the Chinese timber company of fraud. In 2018, the perpetrators of a civil lawsuit against Allen Chan, co-founder and CEO of Sino-Forest, received billions of dollars in damages.
Last week, Block released its last short position, accusing XL Fleet of exaggerating its sales pipeline to justify projections of future revenues.
XL Fleet, which makes electrification systems to convert traditional commercial and municipal vehicles into hybrids, strongly rejected Muddy Waters’ claims in a statement on Monday. Boston-based XL Fleet said the short sales report “contains numerous factual inaccuracies, misleading statements and erroneous conclusions”.
The short selling practice – essentially a bet that a stock will fall – has been examined in the wake of the short squeeze powered by Reddit on GameStop that started in January. The video game retailer’s stock had enormous interest in the open, which some retail investors noticed and started buying GameStop shares and call options that helped drive the price up.
Short sellers borrow shares of a stock and then sell them back on the market, with the aim of buying them back later at a lower price. Then, they return the borrowed shares and profit from the difference. When the opposite happens, as with GameStop, short positions may attempt to repurchase shares at higher current prices to limit their financial losses.
Hedge funds like Melvin Capital, which sold GameStop short, believed that the company’s value would continue to decline while the traditional retailer struggled with e-commerce and more players opted for digital downloads instead of buying the physical disc. Melvin’s founder, Gabe Plotkin, explained the company’s reasoning to sell GameStop at a congressional hearing in February.
Block’s Muddy Waters chooses its short targets differently, often betting against companies it believes are deceiving investors, rather than just having a decadent business in secular decline.
Another Muddy Waters company bet against was Luckin Coffee – announcing a short sale at the beginning of last year, believing that the Chinese company was committing fraud. An internal investigation by Luckin Coffee later determined that its chief operating officer fabricated sales, and the shares were eventually withdrawn from Nasdaq months later.
Block, like all short sellers, has financial incentives for his target stocks to fall and public disclosures of his company’s positions are known to move stock prices, even if it is only temporary. Because of this, some people criticize people like Block for going on television, for example, to discuss their company’s pessimistic bets.
Asked directly by CNBC’s Andrew Ross Sorkin about those who want to place short selling restrictions or argue that Block’s public campaigns against companies “are not the American way,” Block responded.
“The flip side of this is, my perspective is that you are effectively saying, then, ‘Cheat, cheat, exaggerate and make money so this is the American way,” said Block, reiterating that “if we are trying to expose and remove economic incentives for a small number of people to take advantage of naivete, this is American ”.
The volatile action on GameStop and the role that social media played in attracting retail investors to heavy betting stocks raised questions about how short sellers will approach positions in the future. Plotkin, for example, told Congress that he believes hedge funds will adapt their strategies to avoid being caught again in such dramatic restrictions.
One company, Citron Research, has said that it is abandoning the publication of short sales research in favor of seeking long positions.
Although Block says he thinks GameStop may have changed the dynamics in some ways, he said he first saw a noticeable change last year. One company that Muddy Waters shorted “attacked us and this was new,” said Block.
“It told us that there is a lot going on in the market that has nothing to do with fundamentals, and it is really technical,” he said. “Arriving this year before GameStop, we were thinking a lot about flows and how passive [management] and ETFs are really distorting the markets, so when we saw GameStop, I think this is just the trigger of five alarms saying that these markets are really divorced, in many cases, from the underlying asset fundamentals. “