7 months ago • 13 mins
In the early months of the year, stock markets went a little crazy. Hordes of small investors – organizing through online forums like Reddit – ganged together to deliberately push up the price of GameStop and other out-of-favor companies in order to hurt short sellers who were betting against them.
The narrative became one of the people versus the evil financiers, and plenty of bystanders cheered when Melvin Capital, a New York-based hedge fund, was forced to abandon its short positions on GameStop after racking up billions of dollars of losses.
But why have short sellers – investors who sell borrowed stock hoping they’ll be able to buy it back in future for a lower price and pocket the profit – been painted as somehow “evil”? And do they deserve the hatred that’s been hurled their way recently? To defend the sector, we invited Carson Block, founder of the hedge fund Muddy Waters, onto Insights to give the other side of the story in an interview with Finimize analyst Andrew Rummer.
Carson rose to prominence a decade ago after successfully exposing several Chinese companies listed in North America as fraudulent. He then transitioned from publishing research to managing money for clients in 2016 and has become one of the most famous so-called activist short sellers in the world.
Carson started by explaining how he sees the role of short sellers as acting as a check on the behavior of unscrupulous companies.
Carson Block: Most days, I feel like there's some purpose to what we do – and that is trying to hold people accountable. I don't know that our systems of accountability really work much at all anymore. We're probably less successful from a long-term perspective at holding charlatans accountable than we were in the early days, especially when we were focused on those China frauds – the poorly done ones, as opposed to the ones that are out there today that are better executed. You know, at least it's something, right? I think most of these dirtbags just walk the earth today, trouncing anything and everything in their path without so much as a pebble in their shoe. So, at the very least, we're a pebble in their shoe.
Andrew Rummer: You and other activist short sellers are very proud of your work uncovering fraudulent companies that are deceiving investors with artificially inflated profits or other ruses. But that narrative that you’re doing something righteous doesn’t always land with people. Why do shorts attract such vitriol do you think?
Carson: When I first started doing this, with these China frauds, I was getting nasty emails. I mean stuff where it would explicitly, you know, they'd issue a death threat against me, but also – by name – my wife and my father.
Back then, I tried to reason with some of these guys. I mean, not the people who sent that, because you can't, but I said, “Listen, I understand your anger, but you really need to be angry at these people because they've been lying to you.” And that never went over well. It was just like “fuck you,” “you suck,” “I hope the SEC locks you up for the rest of your life.”
And I stepped back and really tried to think about it. And this reminded me of when I was in my investment banking job. So this is 1999. And I loathed it. When I worked for the bank, I used to occasionally – when the jackpot got somewhat big – I used to play the lottery. Because, when I would do that, I had the lottery ticket in my pocket and I buy the ticket in my office building in the morning on the way into the office. And so I'd sit there all day with a lottery ticket in my pocket. And when I got a chance to just fantasize, I thought about how the next day, if I won this thing, I could walk into my boss's office and be like, “this is such a shitty fucking job, I just won the lottery, I am out, find somebody else to do this shit.” And it was really a nice, you know, it's really fulfilling fantasy. And so I then said to myself, I think that a lot of people are so mad at me because they're long these highly speculative China stocks because there's some hole in their life, you know – whether it's emotional lack of fulfilment or they're financially insecure – and they want to quit their jobs. Whatever it is, there's some sort of emotional hole. And it's like, these are their lottery tickets. And it's as though I'm grabbing their lottery tickets out of their hand, I'm snatching them out of their hands, and I'm just tearing them up in their faces and throwing the confetti in the air and laughing. That's how they see it. So when I looked at it that way, I understood better the vitriol and it gave me a little bit of empathy for them.
I think there's a real segment of retail that, during COVID, was financially just decimated by COVID. Their businesses, or they lost their jobs, whatever it is, and they're effectively trying to gamble their way out from underneath the debt. Trying to gamble to pay their bills. And after I really thought about that, or after I got clued into that, for retail people like that I feel bad – but it doesn't change the fact that a given shitco is a given shitco. They're making promises that, you know, or, you know, predictions that are just unrealistic. And I get that if you're the one holding the stock, when we come out and short, it seems really unfair and shitty to you. Because if the thing collapsed in a year, you might not be the one left holding the bag. And it seems like we've done this to you, and we've wronged you. I mean, I understand that sentiment. But the flip side of it is: problems don't get smaller and problem companies tend to just suck in more money before they ultimately collapse. And more people are harmed when you let these wounds fester than when you address them. I think that's almost like a law of human existence that problems do not get better through deferral or ignorance – they only get bigger. And, again, if you're trying to gamble your way out from underneath some really tough financial circumstances, you don't give a shit about that –I understand it – but nonetheless, from a high level perspective, it's good to impose some accountability in the markets. We need a lot more accountability in the markets. It's good from the macro perspective, but I understand it's not good from the perspective of somebody who's just lost a bunch of money.
Andrew: Talking about COVID, what’s your take on what happened back in January and February with GameStop and Melvin Capital and the whole “people versus the suits” narrative that blew up? What on earth happened there?
Carson: We've been locked down at that point for close to a year. I mean, just so much shittiness, everywhere – so much death and despair and poverty created by this. Who didn't want to break something, you know? There were times around then, late 2020, that little things would set me off. And I felt like I came really close to just throwing objects through my TV set at that point. I'm so pissed. The 2019 version of me, was a 43- or 44-year-old guy who didn't do shit like that. But the 2020 version of me would pick up inanimate metal objects that were frustrating me and slam them into the ground until I broke them. We were all to some extent fucked up by this thing. So a lot of anger beneath the surface and I think it doesn't take much to set it off. And what you saw online was almost like a virtual version of a riot, or somewhere between a virtual version of a riot and a protest. And so, yeah, people smelled blood. They wanted to break something.
Andrew: What do you say to those who accuse short sellers of driving decent businesses into the ground? Or see the whole business as somehow disreputable or even unpatriotic?
Carson: I think maybe four years ago, the then president of the New York Stock Exchange, Thomas Farley, was testifying before Congress. And his quote was that short selling feels kind of “icky and un-American”. Well, I wish I could have been there to slam his head into the fucking table. Because what are Nasdaq and the New York Stock Exchange doing that's not unpatriotic? I mean, still they roll out the red carpet: they both have offices in Beijing, where they court these companies from China that literally – this is not me speaking in hyperbole – literally are unable to be held accountable for anything. PRC law expressly prohibits any China-based entity or individual from cooperating with an overseas securities regulator investigation without the prior consent of the China Securities Regulatory Commission, which is, I think, very seldom granted.
So these people and all of the hunt, I mean, like the literally hundreds of frauds that were delisted or went dark, after the first wave of exposures. Literally, only one Chairman went to prison in the US. And the reason he went to prison is because he's from Taiwan, not from the mainland. So you have this entire class of companies – I think about 400 now listed in the US out of roughly 3500 US publicly traded companies – that are above the law. How is this patriotic, Tom Farley? American investors are getting fleeced, we’re financing businesses in some cases that are very closely tied to the Chinese Communist Party. They're definitely not the friends of Americans, you know, in American society over the long term. That's entirely unpatriotic.
Now, let's remove China from the equation and speak more generally. Western societies, depressingly, have become really built on a foundation of half truths. I've turned this for years, the “tick the box” Apocalypse. You have to understand that while the frauds that we expose get the majority of the headlines, most of what we do is actually showing what's really going on at companies that their accounting doesn't break the law. It violates the spirit of the law, but not the letter of the law. And that is really what goes on so much in our societies today, where the spirit of the law is routinely violated. But they can do it within the letter of the law, because they have a lot of lawyers and they create a lot of paperwork. And with enough paperwork, you can create enough plausible deniability for almost anything. Very few people get held to account today for stuff that you can almost objectively say is harmful conduct. So, if you define the American way, the British way, in this manner of, “oh, fuck it, we can do whatever we want, so long as it doesn't technically violate the rule,” then yes, we activist short sellers are horrifically unpatriotic, because we're not buying into that. We say fuck the letter of the law. We care about the spirit of the law and these people outside the spirit of the law. And we're going to explain to you what they're doing. And we hope they get poor as a result. And oh, by the way, we're capitalists: so as they get poorer, we get richer – which I think is fairly Anglo Saxon to use that term – it's almost a pejorative they use on the continent in Europe when they talk about short sellers. But, anyway, so in one sentence, that's bullshit. And if we as activist short sellers are unpatriotic, then our countries have adopted the wrong systems.
Part two of this interview will be published in coming days.
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