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Carson Block defended the practice of short selling on Wednesday, telling CNBC it played a crucial role in protecting investors by identifying companies that could mislead investors.
“I got into this business 11 years ago helping to eliminate a number of frauds from China that were listed in the United States,” the founder of Muddy Waters Research told Squawk Box. “We have eight company write-offs around the world and two other regulatory actions that have led to sanctions. It feels more American to me when we protect investors.”
Block has been a closely watched short seller since betting against Sino-Forest, which was eventually delisted from the Toronto Stock Exchange in 2012, following the 2011 Muddy Waters report. He accused the Chinese timber company of fraud. In 2018, plaintiffs in a civil case against Allen Chan, co-founder and CEO of Sino-Forest, received billions of dollars in damages.
Last week, Block made public its latest short position, accusing XL Fleet of exaggerating its sales pipeline to justify future revenue projections.
XL Fleet, which makes electrification drive systems to convert traditional commercial and municipal vehicles to hybrids, strongly dismissed Muddy Waters’ claims in a statement Monday. XL Fleet, based in Boston, said the short selling report “contains numerous factual inaccuracies, misleading statements and erroneous conclusions.”
The practice of short selling – essentially betting that a stock will drop – has come under scrutiny following the short-term Reddit-fueled squeeze in GameStop that began in January. There was huge short-term interest in the video game retailer’s stock, which some retail investors realized and started buying GameStop shares and call options which helped push 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 stock and profit from the difference. When the opposite happens, as with GameStop, shorts may seek to buy back the stock at current higher prices to limit their financial losses.
Hedge funds such as Melvin Capital that bypassed GameStop believed the value of the company would continue to decline as the physical retailer struggled to switch to e-commerce and more gamers turned to digital downloads. instead of buying the physical disk. Melvin founder Gabe Plotkin explained the company’s reasoning for bypassing GameStop during a congressional hearing in February.
Block’s Muddy Waters chooses its short goals differently, often betting against companies it believes are cheating investors, rather than just having a languid business in secular decline.
Another Muddy Waters Company bet against was Luckin Coffee – announcing a short early last year, believing the Chinese company was committing fraud. An internal Luckin Coffee investigation later determined its COO had fabricated sales, and the stock was eventually delisted from the Nasdaq months later.
Block, like all short sellers, has financial incentives to keep his target stocks down, and public disclosures of his positions have been known to move stock prices, although this may just be temporary. For this reason, some people blame people like Block for going on TV, for example, to discuss his company’s bearish bets.
Asked directly by CNBC’s Andrew Ross Sorkin about those who want to impose restrictions on short selling or who argue that Block’s public campaigns against corporations are “not the American way,” Block pushed back.
“The other aspect of this is, my point of view, is that you actually say though, ‘Cheating, scamming, exaggerating and getting money for this is the American way,’ Block said, reiterating that” if we’re trying out there to expose and remove the economic incentives for a small number of people to take advantage of naivety, that’s American. “
GameStop’s volatile stock and the role social media has played in attracting retail investors to high-stake stocks have raised questions about how short sellers will approach positions in the future. Plotkin, for example, told Congress he believes hedge funds will adapt their strategies to avoid being caught in such short pressures again.
One company, Citron Research, has previously said it is moving away from publishing research on short selling in favor of looking for long positions.
While Block said he believes GameStop may have changed the dynamics in some ways, he said he first saw a noticeable change last year. A shorted-out Muddy Waters company “tore us apart, and that was new,” Block said.
“It told us that there is a lot going on in the market that has nothing to do with fundamentals, and it’s really technical,” he said. “Coming this year before GameStop, we put a lot of thought into the flow and the [management] and ETFs are really distorting the markets, so when we saw GameStop I think it was just the five-alarm fire saying that these markets are really separate, in many cases, from the fundamentals of the underlying asset. “
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