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.