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Carson Block Highlights China’s ‘Risky Business’

Posted by Larry Doyle on July 27, 2011 8:46 AM |

With the United States on the precipice of having its AAA credit rating downgraded, there would clearly seem to be a new world order dawning.

Many investors have already shifted their portfolios to increase holdings in emerging markets. Which region has generated the greatest focus? Asia.

Many view Asia and specifically those nations running large fiscal surpluses as being best positioned to prosper and profit as we move further into this century. The Peoples Republic of China garners the greatest interest by many global investors based upon its size, scope, and power.

Well, not unlike those who went west here in America in the mid-1800s, those seeking riches over the Great Wall had best be very careful. Who can run some interference for us and help us navigate this corner of our global economic landscape?

Let’s meet Carson Block, an individual who swims against the tide and is willing to put his money where his mouth is. As such I welcome making Block the newest inductee into the Sense on Cents Hall of Fame.

Who is Carson Block? Those in the financial industry likely know Carson quite well but for middle America, Carson Block is probably an unknown. As a resident Hall of Famer, and one who goes where many would not dare, he deserves greater exposure. On that note, I am happy to highlight a recent Financial Times piece profiling Mr. Block.

The FT writes, Block Homes in On Weak Points in the System,

Just one year ago, Carson Block was the little-known boss of Love Box, a struggling self-storage company in Shanghai.

Today he is the best-known short seller in the China market, having triggered collapses in the share prices of six Chinese companies listed in the US and Canada, three of which have subsequently been suspended or de-listed.

“I realised this problem was systemic and that I’ve got the skill set that allows me to expose these frauds and take them out of the market,” Mr Block told the Financial Times in a recent interview.

A 35-year-old New Jersey native and fan of 1990s gangsta rap music, Mr Block published his first report on his Muddy Waters Research website on June 28 2010, alleging fraud at Orient Paper, a company that trades on the American Stock Exchange.

“By hitting send on that report the world changed tremendously for me,” he says. “I had no expectation it would get any interest or attention. It was more a way to document my expertise.”

Mr Block says he took out a very small short position in Orient Paper – “the kind of money that didn’t really matter” – before he sent out his report but he soon realised the potential goldmine he had stumbled across.

Orient Paper’s shares collapsed after the report came out last year and are still trading at about half the price they were before Muddy Waters’ report was released.

The Chinese paper company has denied Muddy Waters’ allegations vehemently and published a report from its audit committee, assisted by accountants at Deloitte, which after a four-month probe found no evidence to support most of the short seller’s claims.

Mr Block started his career in the equity research business, working university holidays and then full time at WAB Capital, his father’s firm, which specialises in producing research reports for institutional investors on “micro-cap” companies listed in the US.

In fact, his first visit to Orient Paper was originally at the behest of his father, who was interested in providing research on small Chinese companies listed in the US.

Mr Block says his current position at the “vanguard of investment counter-culture” comes as no surprise to people who knew him growing up, when he says he had “a lot of disciplinary problems at school” and a “problem with authority”.

“I always pissed a lot of people off, stepped on a lot of toes in my life but probably a part of me enjoys that,” he says.

After graduating from the University of Southern California, Mr Block moved to Shanghai in 1998 with the intention of setting up an equity research company there. It did not work out and he returned to the US within six months, working mostly for his father’s company until 2002, when he went to study law at the Chicago-Kent College of Law.

After graduating in 2005, he returned to Shanghai and worked as a paralegal for Jones Day, the US law firm.

“He was quite an arrogant guy with an independent and somewhat restless streak,” says one person who knew him around this time. “He was certainly not dishonest in any way.”

He quit Jones Day in late 2006 with a plan to set up a private banking business in Singapore but ended up founding Love Box, a self-storage business, and co-authoring Doing Business in China For Dummies in 2007.

He says the experience of being an entrepreneur in the cut-throat and opaque world of Chinese business set him on the path to becoming a short seller.

“I had a lot of friends in Shanghai who were also entrepreneurs and after getting our asses kicked [financially, not literally] we saw another side of this place,” he says. “We were asking if we were crazy or if the rest of the world was crazy because what the rest of the world thinks goes on here doesn’t mesh with the reality we observe.”

He says that at least some of the blame for the irregularities and fraud he alleges takes place at offshore-listed Chinese companies should be levelled at the “enablers” – the bankers, lawyers, accountants and stock promoters who have brought hundreds of small Chinese companies to US and other markets, often through reverse takeovers. (LD’s highlight)

Couldn’t we make the same assessment here in the U.S? No doubt. Included in the ‘enablers’ we should include the regulators and rating agencies who have been shown to be negligent, incompetent, or merely incapable in protecting investors.

“In terms of these enablers’ states of mind, it runs the gamut from wilful ignorance to strategising and actively managing frauds,” Mr Block says.

His work has led to death threats and he is currently based in the US, partly because of fears for his personal safety.

“As a short seller what you say is inherently less popular than the analysts who spit out buy recommendations all day,” he says. “You realise there’s less margin for error on the short side than the long side because people look at it more closely.”

I am not so dense as to unilaterally endorse each and every statement or research piece by Carson Block and his colleagues at Muddy Waters. However, Block and team certainly seem to pursue our badly needed virtue of transparency which is critical to finding the truth.

Whom does Carson Block remind you of? Perhaps a grown up version of Ferris Bueller? How about, Joel “Princeton could use a man like you” Goodson of the classic movie Risky Business? For those reasons alone, Block is further accorded special status in our Hall of Fame.

In all seriousness, though, Block and Muddy Waters provide a very valuable service. If you are investing, or dare I say navigating, in the Chinese markets, I strongly recommend you follow their work.

Larry Doyle

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I have no affiliation or business interest with any entity referenced in this commentary. The opinions expressed are my own. I am a proponent of real transparency within our markets, our economy, and our political realm so that meaningful investor confidence and investor protection can be achieved.


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