Opinion

Alison Frankel

Muddy Waters indeed! China stock analyst claims blackmail, libel

By Alison Frankel
July 22, 2011

The whirlwind of controversy surrounding supposed securities fraud by China-based, U.S.-listed companies spins ever faster. Today’s development: an utterly fascinating libel and defamation complaint that a tiny Hong Kong research outfit called Muddy Waters filed late Thursday in Los Angeles Superior Court against yet-unidentified defendants.

Muddy Waters and its founder, a onetime Jones Day lawyer named Carson Block, have been at the red-hot center of allegations that Chinese companies are fleecing U.S. investors. Block knocked around a bit after graduating from Chicago-Kent College of Law: he practiced law in Shanghai at Jones Day, then started up a Chinese self-storage company and wrote a book about doing business in China. In 2010, Block’s father, the founder of W.A.B. Capital, was considering an investment in a company called Orient Paper and asked his son to check it out. When Carson Block and a friend visited Orient Paper’s headquarters, according to a Dealbook profile of Block, they allegedly found heaps of junk masquerading as corporate assets.

Block put out a report on Orient Paper, urging traders to dump the stock. (As OTC reported yesterday, a federal judge in Los Angeles just green-lighted a securities fraud class action against the company.) And thus a research company — and short -seller — was born. Block was inspired to call his new firm Muddy Waters, according to the company website, by an old Chinese proverb that says it’s easy to catch fish when the fish can’t see what’s going on. His research philosophy is that some Chinese businesses have been taking advantage of U.S. investors who don’t know what’s really happening on the other side of the world. Muddy Waters promised to expose fraud-racked companies through on-the-ground investigation. It also wasn’t shy about admitting that it intended to make money by shorting the stocks of the companies it was about to expose.

In the year since Block founded Muddy Waters, he’s issued negative reports on a half-dozen China-based companies, including a fair percentage of the Chinese securities fraud defendants in the U.S. Most notoriously, a Muddy Waters report sparked the enormous June sell-off of Canadian-listed shares of Sino-Forest. Sino-Forest’s swoon cost U.S. investors, including hedge fund manager John Paulson, hundreds of millions of dollars but brought Muddy Waters and its founder quite a bit of attention. Block’s newfound fame had its advantages — he was profiled in the New York Times and the Wall Street Journal — but also a dark underbelly. Critics such as Perrie Weiner of DLA Piper, who represents several Chinese companies in securities fraud cases, complained to Dealbook that short sellers like Block were engaged in rumor-mongering to make money for themselves. (Weiner didn’t return a call from me.) Orient Paper claimed Block and his father tried to blackmail the company. Sino-Forest threatened to sue Block and Muddy Waters for defamation.

And someone did much worse than that. On June 21, an anonymous poster put out a press release on a public website called Briefingwire.com, claiming that the U.S. Securities and Exchange Commission had charged Block and Muddy Waters with fraud. The press release said Block had realized $240.2 million in ill-gotten profits through manipulating stock prices of three publicly-traded Chinese companies. The document had an aura of authenticity — it quoted longtime SEC enforcement division lawyer Scott Friestad, for instance, and accused Muddy Waters of manipulating stock in companies Block short-sold, including Sino-Forest. But as Reuters reported later that day, the press release was a sheer fake.

Meanwhile, another Muddy Waters-hater is out there pretending to be a Muddy Waters employee issuing blackmail demands. According to the libel complaint the company filed Thursday, a third party informed Muddy Waters that someone calling himself “Shaun Coffey of Muddy Waters” left “Mr. Wong” a phone message in Hong Kong that said, “Have you reported out [sic] meeting to your bosses? Now they only have 2 choices, to either pay us 2 millions [sic] U.S. dollar or we will release our initial research report to public. You must reply or within 2 days!” (The former federal prosecutor, Sean Coffey, now running a start-up litigation funding company called BlackRobe Capital, told OTC he has no ties to Muddy Waters.) In a Muddy Waters press release announcing the suit, the company says the extortion demand was made to a public company.

Block and Muddy Waters are represented by Donald Burris of Burris, Schoenberg & Walden, who met Carson Block through Block’s father, a Burris client. The law clearly has some work ahead of it if Muddy Waters is going to make a go of the case. The defendants are now listed as Does 1-100 because Muddy Waters doesn’t know who was behind the fake press release or the alleged blackmail threat. Burris told me Friday that Block — who says he has received death threats because of his research reports — suspects the fake release and the fake extortion threat were made by people with similar motives, but he’s not sure. In announcing the suit, Block said the case “enables us to begin an investigation to which we will direct significant resources.”

Briefingwire.com is protected by the Digital Millenium Copyright Act, but Burris said he plans to ask the Internet site to turn over whatever information it has on the poster of the fake press release. “There’s no reason to go after the website, although we think they were awfully sloppy,” Burris said. “We believe when we request information through litigation, they will need to identify [the poster].” (Briefingwire didn’t respond to Reuters e-mails when it first published the fake release.) Block’s announcement of the litigation says that he is hoping the case “will lead to better controls, consistent with the legitimate First Amendment constraints, on the publication and dissemination of defamatory material by anonymous or ill-defined authors.”

Burris also said Muddy Waters is going to investigate whatever can be gleaned from the fake press release itself. The faux document, which the libel complaint quotes in its entirety, says Block “carried out the market manipulation schemes with others he met through a stock web site, which is operated by Matthew Brown of Aliso Viejo, Calif. Block, Brown, and other participants in the schemes often timed the manipulative trading to coincide with the false and misleading press releases issued by Muddy Waters.” The fake release claims the SEC lodged charges in Delaware federal court.

Here’s the weird thing: A Californian named Matthew Brown, who once ran a penny stock website called InvestorsHub, really was charged in Delaware civil and criminal stock manipulation cases. (Here’s the 2009 SEC complaint; the case was stayed for criminal proceedings.) According to the docket in the criminal case against him, Brown pled guilty to four fraud-related counts in February 2010 and was sentenced in May to four years in prison. I called Brown’s lawyer, Delaware solo John Garey, to ask about his possible ties to Muddy Waters but didn’t hear back.

This is going to be a wild case if Muddy Waters and Burris can make headway in their investigation. Turns out there aren’t just fish swimming in the muddy waters of China stock research: there are also sharks.

(Reporting by Alison Frankel)

 

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