Bloomberg News

Short Seller Block Takes On Paulson, Greenberg in China (1)

June 06, 2011

(Updates with television interview in 11th paragraph, today’s trading in 12th.)

June 6 (Bloomberg) -- Carson Block, a gangster rap enthusiast who doesn’t like to give his exact address because he said he’s received death threats, is taking responsibility for billions of dollars in stock declines that have left everyone from John Paulson to Hank Greenberg nursing losses.

Sino-Forest Corp., an operator of timber plantations backed by Paulson & Co., plunged 71 percent in two days last week after Block’s Muddy Waters Research said it was betting against the shares. Paulson, whose New York-based hedge fund earned $15 billion in a single year while Block was developing a company called Love Box Self Storage in Shanghai, may have lost $325 million on Toronto-traded Sino-Forest.

“There are going to be people who say, well, I caused this,” Block said in a telephone interview from Hong Kong. “In one sense, yes, had I not published on that date, then the money would not have been lost. But on the other hand, I really feel that this company is a cancer on the financial system, because it just keeps sucking in more money every year.”

Block made a name for himself with China MediaExpress Holdings Inc. and Rino International Corp., saying they manipulated financial statements. China MediaExpress counted former American International Group Inc. Chief Executive Officer Greenberg’s C.V. Starr & Co. as a top owner. The shares have slid 93 percent since Block’s February report. Rino said in November that its financial statements were unreliable, less than two weeks after Block published his statements, and is down 96 percent.

‘Shock Jock’

Allen Chan, chief executive officer of the Hong Kong and Mississauga, Ontario-based Sino-Forest, called Block’s research “inaccurate and unfounded” and said “Muddy Waters’ shock-jock approach is transparently self-interested” in a June 3 statement. The company plans to establish a committee of independent directors to examine the accusations, according to the statement.

Paulson & Co., which made $15 billion in 2007 betting against subprime mortgages, said in a June 3 letter to investors that Sino-Forest represented about 2 percent of the firm’s Advantage and Advantage Plus funds as of June 2. Paulson said the firm is investigating claims by Muddy Waters.

Armel Leslie, a spokesman for Paulson, and Jake Sokol, a spokesman for C.V. Starr, the investment company owned by Greenberg, didn’t respond to phone and e-mail messages seeking comment outside normal business hours yesterday.

New Product

The 35-year-old Block, who doesn’t keep a permanent office and said 1990s hip hop is the most-recent music he listens to, says his success is the flip side of Wall Street’s shortcomings when it comes to China.

“I’ve started to think of investment banks and the investment banking industry as just manufacturers of financial products,” he said. “They have to keep bringing new product to market, and in a situation where there’s so much pressure to do that, you’re definitely going to have poor financial product that gets brought to market.”

The five companies Muddy Waters has publicly reported on have lost almost $4.4 billion in market value from the last trading day before publication of his research through June 3. In a short sale, a trader sells borrowed shares on speculation prices will decline and the stock can be replaced at a lower cost.

‘Ponzi Scheme’

Sino-Forest is “a Ponzi scheme as it perpetually issues new securities to fund itself,” Block said in an interview on Bloomberg Television today. “Were the company unable to issue additional securities, it would collapse.” He said his company will keep betting against the shares until they reach “zero.”

His note on Sino-Forest last week, in which he said the company overstated timberland holdings and production, wiped out C$3.19 billion ($3.25 billion) in market capitalization in two days. Sino-Forest gained 12 percent to C$5.88 at 2:30 p.m. in Frankfurt trading. Investors in Rino International have lost $426.2 million and that company is now valued at $17.7 million.

“The buck keeps getting passed around, from the foreign counsel that works on these deals, to the Chinese law firms, to the investment bankers to the auditors,” he said by phone. “And everyone’s just passing the blame around like a hot potato because there are gaps in the system.”

Biggest Target

Sino-Forest is Muddy Waters’ biggest target to date. Ten researchers spent two months looking at the business, and government records indicated the company would have a capital hole of as much as $922 million if it had made the investments it claimed, according to the June 2 report.

“Why did it take a guy like Carson Block to reveal this?” said Robert Lawton, managing partner of Catoosa Fund LP, a Los Angeles-based hedge fund which lost money on China MediaExpress. “You have people like Paulson and Greenberg, who you would believe did their research before they took a position in these stocks. What did they miss in advance of buying stocks that it took Block a couple of months and a staff of 10 to uncover? If I had been invested with Paulson and Greenberg I would be furious.”

Block decided to start Muddy Waters after visiting a company called Orient Paper Inc. at the behest of his father, William Block, who runs Pacific Palisades, California-based W.A.B. Capital LLC, a firm that helps introduce small companies to institutional investors. Muddy Waters was born of the realization “that there is a gaping need for due diligence in China equity research,” Block wrote in a July 2 article.

Started Early

The younger Block “grew up” in the equity research business, working part time as an analyst in college and passing his broker’s license exam at 19, he says. His interest in Asia also started early when he spent a summer living in Japan during high school. He first went to Beijing in 1997 and moved to Shanghai after graduating from the University of Southern California with a degree in business administration in 1998, he says.

Block’s plan to get into equity research in China fizzled in 1998, he says. In 2005, with a law degree from Chicago-Kent College of Law, he returned to Shanghai to work on foreign direct investment and merger deals at the law firm Jones Day. He quit in 2006, planning to start a private banking business in Singapore, and ended up founding the storage rental business Love Box instead.

The company’s tag line is “get self storage without BS,” and its website includes a section on “Shanghai Without BS,” guides that offer advice, tips and Chinese vocabulary on such topics as having pets, grocery shopping and “cheap & easy decorating.”

Self Storage Switch

Block’s switch from self storage to short selling began in January 2010 with the visit to Orient Paper.

As he toured the company, Block describes thinking it resembled a “pretty bad Potemkin factory,” referring to facades supposedly built in the 18th century to mislead Catherine the Great of Russia about the nation’s economy. “And this is a company that in micro-cap world has received a lot of praise,” he says. “That’s when it seemed there was some opportunity there, but I had no idea how big it was.”

He bet against the shares, his first short sale, and Muddy Waters issued a report on the stock on June 28, 2010.

Orient Paper denied the assertions and an audit committee- organized investigation of the claims dismissed most of them. The shares have dropped 57 percent since the Muddy Waters report. Crocker Coulson, a U.S.-based outside spokesman for Orient Paper, didn’t return an e-mail and a phone message seeking comment late yesterday.

‘Churnham & Burnham’

The Muddy Waters website displays the words “Churnham & Burnham, est. 1792” next to a map of China at the top and rotating quotations, including from the character Gordon Gekko in the 1987 film “Wall Street.”

“At times, I’ve felt like there is an element of ‘Wall Street’ to this, because by virtue of being in China and understanding what’s going on, it’s a tremendous edge,” Block said. “The kind of edge that Bud Fox was looking for from Gordon Gekko.”

“We really talk about these companies from an operations perspective and try to understand that, whereas typically in the investment field they’re looking at it from a financial model perspective,” Block says.

Rino Call

Block’s rise to prominence began with Rino in November. Nine days after his report, which said the company had overstated its sales and claimed contracts that didn’t exist, the maker of water-treatment equipment disclosed that two years’ of financial statements aren’t reliable.

It was cemented after his February report on China MediaExpress. The company’s auditor, Deloitte Touche Tohmatsu, resigned five weeks after Block’s accusations, saying it was “no longer able to rely on the representations of management.” The Chinese company’s chief financial officer also resigned.

Hank Greenberg’s C.V. Starr was among China MediaExpress’s largest owners along with New York-based hedge fund D.E. Shaw & Co. and Goldman Sachs Group Inc. as of March 31, according to data compiled by Bloomberg.

Stephen Cohen, a spokesman for New York-based Goldman Sachs, declined to comment.

Regulators and investors have increased scrutiny of Chinese companies trading in North America. The U.S. Securities and Exchange Commission began an investigation last year into the use of reverse takeovers, in which a closely held firm becomes public by purchasing a shell company that already trades. The Bloomberg Chinese Reverse Mergers Index of U.S.-listed stocks has fallen 40 percent this year.

Revoked Registrations

The SEC has revoked the registrations of at least eight China-based companies since December, and more than 24 firms have disclosed auditor resignations or accounting problems to the agency since March, SEC Chairman Mary Schapiro wrote in an April 27 letter. The agency may sue at least one China-based auditor for obstructing a probe of reverse mergers after Chinese regulators blocked the firm from providing requested data, a person with direct knowledge of the matter said in May.

The success of Muddy Waters, Los Angeles-based Citron Research and other short sellers of Chinese stocks that trade in North America has prompted assertions of stock manipulation. Investors shouldn’t trust short sellers to tell the truth when they stand to benefit from share declines, says Kevin Pollack, a fund manager at New York-based Paragon Capital LP who invests in U.S.-listed Chinese stocks.

‘Own Agendas’

“It is important to recognize that shorts and bloggers have their own agendas and that you have to take their allegations with a grain of salt,” he said. “I have seen a lot of exaggeration and inaccuracies in short seller promulgations.”

Block said if his reports weren’t accurate, nobody would act on them. While his firm’s profit is tied to his short positions, the motivation for Muddy Waters isn’t entirely commercial, he said.

“You can take a short position in a stock and you can do that just for money,” he said. “But truthfully, when you’re doing what we’re doing -- being the lightning rod -- you can’t do this just for money. There are easier ways to make money.”

The attention to his reports has also brought death threats and critical e-mails, Block said. While the threats stopped after his first reports stood up, his life has changed.

“A year ago, I was worried about whether a guy would pay his $80-a-month rent on his self-storage unit in Shanghai, and now I’m worried about whether I’m going to be hit with $100 million lawsuits,” he said. “That’s a big change.”

--With assistance from Matt Walcoff in Toronto and Kelly Bit and Erik Schatzker in New York. Editors: Jeff Sutherland, Chris Nagi

To contact the reporters on this story: Dune Lawrence in New York at dlawrence6@bloomberg.net; Nikolaj Gammeltoft in New York at ngammeltoft@bloomberg.net

To contact the editors responsible for this story: Nick Baker at nbaker7@bloomberg.net; Gary Putka at gputka@bloomberg.net


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