#15 – The Short Seller

Carson Block Cartoon - BTBS

Carson Block is one of the world’s top short sellers, and one of few still managing a specialist fund.

SUMMARY

In this interview, Carson explains the business of short selling; the difference between fundamental shorting and his business of shorting and exposing frauds; how he spots these fraudulent companies; where to find frauds; and why it takes Muddy Waters 3 months to launch a short campaign. We discuss the economics of a short fund, why short selling is so much more difficult than long only  investing and why Europe is a more difficult area to operate.

This was a fascinating exposition of the difficulties of a business which is essential to the honest operation of markets yet whose economics have become less attractive. You will be left in no doubt as to why Carson’s firm, Muddy Waters is one of the last men standing. And in an exclusive, Carson reveals that he wants to move away from the “activist short-seller” nomenclature and tells us his proposed new business description.

GETTING INTO INVESTING

Carson’s story of transition from Chinese self storage entrepreneur to his first early short selling campaigns on Chinese frauds is well known so we only touched on this briefly. But he believes that he has a psychological bent towards shorting and that there is a major difference between his work and fundamental short selling. His work is factual rather than opinion and fundamental shorts, whether they are melting ice cubes, exposure to competition, or new product failures and similar, cannot be proved right in the present. His shorts don’t need to wait for the future to unfold which is a critical difference.

THE BUSINESS OF SHORT SELLING

The economics of a short selling shop don’t quite have the attractions of a long only firm in a bull market. You don’t get the natural growth in AUM and revenues, but it’s worse. Carson laughs that in the last couple of years, people who were prepared to dive of the high board blind were being rewarded – investors were being paid for risk. Whereas in his business it costs $0.5m to get rid of a harassing lawsuit. And his firm, Muddy Waters, only has capacity for 4-5 big campaigns a year.

SPOTTING FRAUDS

Muddy Waters doesn’t use screens to find short candidates – there are too many false positives and false negatives. Rather their process is much more qualitative. Carson pays particular attention to stocks on a tear, to highly promotional management, to CEOs promising the moon. They like companies which are indebted and resort to trickery to preserve covenants. They will read call transcripts for several years to detect broken promises, management prone to using buzzwords, executives who don’t answer questions.

ABOUT Carson Block

Carson Block is the founder of Muddy Waters Research. He grew up in New Jersey, has an undergraduate degree from the University of Southern California and a J.D. degree from Chicago-Kent College of Law. He started work for his father as a stockbroker, before going to law school, moving to Shanghai to practise law, and then setting up a self-storage business in China in 2007. His first major short selling campaign was Orient Paper and he then launched activist short selling, highlighting Sino Forest in a report. Block is best known for exposing fraudulent accounting practices in publicly traded Chinese companies and in 2011, he was ranked as a 50 Most Influential Thinker by Bloomberg Markets.

carson pic from delivering alpha

Source: Delivering Alpha

BOOK RECOMMENDATIONS

Carson recommended three books, all related to fraud or company failures. He recommends investors study these to learn more about incentives and disincentives and what these can lead to.

When Genius Failed: The Rise and Fall of Long Term Capital Management Paperback by Roger Lowenstein

This is a book by an investigative journalist. Fatal Risk: A Cautionary Tale of AIG′s Corporate Suicide Hardcover by Roddy Boyd 

The third book is about corporate hubris. Crash of the Titans: Greed, Hubris, the Fall of Merrill Lynch, and the Near-Collapse of Bank of America by Greg Farrell

HOW STEVE KNOWS THE GUESTS

Steve was one of the first guests on Zer0es TV, Carson’s TV channel, and he subsequently had a call with Carson and his number 2, Freddy Brick. Steve and Freddy subsequently met up in London and after Greensill collapsed, Freddy interviewed Steve about how he had spotted the early signals. When he launched the podcast, Steve decided to make short sellers one of the themes and the podcast has so far featured Dan McCrum and Carson Block with others in the wings.

 

CHAPTERS

00:02 – Introduction to Investing Basics
08:27 – Discovering the Short Selling Path
25:40 – The Power of Public Criticism
38:28 – Uncovering Deception in Financial Statements
54:04 – The Art of Asking Questions
01:09:05 – Facing Challenges and Investigations
01:18:45 – CEO Personalities and Company Impact

 

TRANSCRIPT 

STEPHEN CLAPHAM: Carson Block is one of the world’s top short sellers and one of the few surviving managers of a specialist short selling fund. Carson has been on a lot of podcasts so we agreed to spend less time on his journey to becoming a short seller. Fascinating though, that story is and more on where he finds frauds and what he looks for.

STEPHEN CLAPHAM: I was surprised but delighted that he was prepared to share some of the techniques you as an investor can employ to dodge these bullets. You don’t want a fraud in your portfolio. And in an exclusive, Carson explains why he’s become dissatisfied with the description activist short seller and his new term for what he does.

STEPHEN CLAPHAM: This was a fascinating exposition of the difficulties of a business which is essential to the honest operation of markets yet whose economics have become much less attractive. You’ll be left in no doubt as to why Carson’s firm Muddy Waters is one of the last men standing.

STEPHEN CLAPHAM: So Carson, welcome to the podcast. This is so exciting for me because I’ve been wanting to do this for ages and it’s taken a little bit of time to organize. I’m so grateful to you for giving up the time and it’s very funny that we should be doing it today because it’s the 21st of September when we’re recording and in my inbox just before I got on the call with you.

STEPHEN CLAPHAM: There was an email from my pal Whitney Tilson talking about short selling. And what he said was, he said over 15 years of short selling, I made a lot of money in 2008 and in early 2009 and in 2015. But otherwise I mostly took a beating. It cost me a lot of money and started to have a huge amount of time. And the thing about short selling is people that aren’t, haven’t been involved with it.

STEPHEN CLAPHAM: I don’t think they understand it’s psychologically very difficult. I mean, I don’t think people realize how hard it is when I was at the hedge funds. I mean, I always found shorts that were much harder than longs. The psychology is different when you’re in loss, you need more of them because you’ve got smaller positions and they require you to be much cuter in the timing.

STEPHEN CLAPHAM: That’s obviously for a fundamental short seller. What, why did you get involved in short selling? And what do you think are the, the, the, I mean, the things that make a good short seller?

STEPHEN CLAPHAM: Talk about the psychology of it.

CARSON BLOCK: Sure. Ok. So first of all, thank you for having me, Steve a long time admirer of yours and you’ve also been on XS TV. So, yeah, really excited to do this as well.

CARSON BLOCK: As far as the, the, the frequent futility of short selling, I will second what Whitney wrote some years ago, I met one of the legends of the hedge fund world. Somebody whose last name starts with an s there are two of them. And he said to me said, I, when, when we were short selling, we did far more work than anybody on the long side did.

CARSON BLOCK: I, I used to say that we knew these names. We done more work on these names than anybody when we were short, these names like and after all that, over all of the years that we had that we were a hedge fund, I think on our short book net net, we were flat.

CARSON BLOCK: So there is in many ways a there can be a futility to short selling or it certainly can seem that way.

CARSON BLOCK: Now why I got into it and that dovetails with your question somewhat about the, the psychology I grew up in the industry. On the long side, my father was an equity analyst who was also an institutional sales person and he was focused mostly on microcap and small cap companies.

CARSON BLOCK: And he literally was known as the, the most bullish or credulous analyst on the street. Right after I wrote my first short report in 2010 on orient paper. I sat down with a journalist, Bill Alpert Barons and Bill is grizzled veteran of financial investigative reporting.

CARSON BLOCK: And Bill said to me referring to my father, his first name is also Bill. He said, I first heard of Bill Block when I took a sabbatical from journalism and I worked at a hedge fund and we had a strategy where we shorted everything your father ever put a by recommendation on.

CARSON BLOCK: And it was really funny to me because my father’s the guy who used to work for him as a traitor for many years, used to sometimes rib my father and say to him, Bill, the day you retire, there’s gonna be this one guy who’s devastated because he shorted everything you ever put a buy on.

CARSON BLOCK: And I’m like, I, I’m meeting the guy. Number one then number two, God, there must have been a lot more than just one guy who was shorting everything my father put a buy on and the reality is my father was never, you know, was nothing craven on his part.

CARSON BLOCK: I mean, he was never in on the joke. He was easily taken by charisma still is to this day Trump voter. So he loves charismatic management stories and I guess, you know, for to getting to, you know how I got, how I ended up here and what the makeup of a, of a short seller should be.

CARSON BLOCK: I worked with my father. It was, it was a little bit out of, I was a little bit out of undergrad. So I had gone to China right after I graduated in 98. Tried to start an investment research business there realized I was like a decade too early, came back to the States, worked at a large I bank for nine months, loathed it maybe only eight months.

CARSON BLOCK: And then I teamed up with my father and so I made good money the first year and a half. But that was, we’re talking now 2000 through 2002 and 2002, was just different. Every, you know, it seemed that all of these managements or many of them had been lying to us and using us to get our institutional clients to buy their stocks.

CARSON BLOCK: And then we turn around and we’d see, you know, 45 days later because we had more time to file the forms for, we’d see that they dumped the stock and it was very embittering time. And, you know, my father, at that point, he said to me because I was always, you know, on the long side then I was, I was, I was always willing to take profits really early and say, look, we thought it was gonna go up 30% in one year. It’s up 40%.

CARSON BLOCK: I’m gonna sell my holdings and, you know, my father wouldn’t sell his and he would, you know, he said, oh, you get hit with taxes. And I say, yeah, that doesn’t matter if you’re gonna lose money. So he, the irony is he was telling me at that time. He said, you know, I think you’re, you’re just much more conservative than I am and maybe you should look into short selling.

CARSON BLOCK: Ok. Well, who do you know who does that like? Oh, I know one guy in San Francisco but I think he’s an asshole so I’m not gonna call him.

CARSON BLOCK: All right, thanks. So I left the investment industry and went to, went to law school. And I went to law school because I was, I was trying to learn how to better protect myself against financial predators.

CARSON BLOCK: I mean, I was, I it’s hard to overstate just how fucking furious I was at this point in time after what I perceived as, I mean, well, reality for having been lied to by a number of these managements. So, I, I fell out of the market and got back into it by accident. So I wasn’t looking to be a short seller when I got back in. It’s just years later I diligence a company in China.

CARSON BLOCK: My father asked me to look at that did not expect it to be a fraud. I mean, to me, the question was, is the guy stealing too much a more than acceptable amount of money out of the company because you know, it’s China like they’re gonna steal something.

CARSON BLOCK: But it turned out to be a total fraud and I just put this report together for the hell of it. I, I didn’t really have a business plan and then when I, I mean, that report went viral all of a sudden, you know, the, the next generation of big hedge fund guys is emailing me wanting to take meetings.

CARSON BLOCK: And when I realized like, wow, ok, there’s this, this part of my personality that not per part, I mean, this, this dominant aspect of my personality that I think a number of people had maybe thought was somewhat antisocial, was troublesome, argumentative.

CARSON BLOCK: I’m just like, there’s actually a way I can monetize this. You know, I’ve been, I’ve, I mean, I’ve, I’ve had people dislike me for a long time because I would say things out loud that were just unpopular. And sometimes I, I would, I would, I love the debate. I love to push people on their positions and even if I agree with them, I’m, I’m often taking the other side just for the debate and, and that’s how I love to think.

CARSON BLOCK: I love to take, you know, a narrative and then think about the counter narrative and, and test it. So I think that those traits are necessary to be a short seller and, and I was just, I really felt like I found myself all of a sudden when I realized I could get paid and paid reasonably well for being openly skeptical and challenging authority and mouthing off.

CARSON BLOCK: Now, there’s an aspect of my business that’s quite different from that of the conventional short seller. I mean, traditionally or conventionally as a short seller, you take a short position and you don’t talk about it. Now, there are a few reasons for this and whereas my model is, is I talk about it.

CARSON BLOCK: Now there are a few reasons for this as, as an activist short seller, you know what, you know what we’re, what we’re called. And I want to get into that nomenclature because I do think the nomenclature should be changed somewhat.

CARSON BLOCK: But we’re investigating what happened or did not happen generally. So we’re not really, you know, our thesis don’t revolve around what’s going to happen. So the vast majority of short sellers are taking shorts for fundamental reasons. They are short.

CARSON BLOCK: What they see is a melting ice cube. They think it’s gonna melt faster than the market does or maybe they think the new product is gonna be a failure or a competition is gonna blow them out of the water.

CARSON BLOCK: Those are all great valid reasons to short a stock, but those are not, those do not make good activist short because you cannot be provably right in the present. So this gets to my nomenclature point, but also really the substance of what we do as activist short sellers.

CARSON BLOCK: I mean, we’re basically investigative journalists, we’re investigative financial journalists and we’re usually saying the company is deceiving you in some way, they’re telling you this, that’s not accurate. They’re telling you that that’s not the whole picture. And they’ve completely failed to tell you about this other thing.

CARSON BLOCK: So that’s, that’s what we do. And if you’re a traditional short seller, your goal cannot be to make money to generate games in your book every year because that’s, that’s not why it’s there, it’s there to create alpha and that’s a noble pursuit. But as far as I’m concerned, you can’t eat alpha and you can’t buy a house with alpha.

CARSON BLOCK: So when you’re more on the investigative journalistic, so, you know, journalist investor side of things, that’s, that’s what I would like to change the nomenclature to when you were a journalist investor, you have to, you, you have to actually find things that are profitable.

CARSON BLOCK: You have to find stories that people are going to care about and where it’s material enough. And, you know, there’s a lot of apathy to overcome and there’s a very crowded information environment with which we need to compete, but, you know, makeup wise to so to do what we do as investor journal or journalist investors.

CARSON BLOCK: This is the first time I’ve used this term publicly. So, so to do that, I think that you need a little bit more than just what the traditional short seller needs.

CARSON BLOCK: You know, you really, you really need to be, you really need to have thick skin and maybe even get a rise out of provoking people and provoking acerbic reactions to what you say and what you write the psychology though is the same.

STEPHEN CLAPHAM: Right, because you’ve still got the same issues that if people don’t believe you, it’s almost worse for you because unless you have an instant fall in the share price, then you’re sitting with a pressure if, if, if your story is not believed.

CARSON BLOCK: So the, the psychology is actually quite the same, you know, I mean, there are, there are, there are definitely parts of it that are, I think that for most of us who short stocks, I mean, we, we probably have a belief, probably believe most of our lives that we’re smarter than a lot of the people around us.

CARSON BLOCK: But, you know, even the people who are more successful and more popular than we are and we’ve probably had like a burning desire to show them up, you know, but I mean, I’m, you know, that I’m not saying that that’s the most healthy psychological trait, but if I’m being honest, yeah, I, I think that that’s probably a big part of what of the psychological makeup of people who go on the short side or at least are, are successful on, on the short side.

CARSON BLOCK: And when I say successful, I’m largely referring as well to to traditional short sellers, not just activist short sellers, but yeah, I mean, you’ve got, there’s got to be a tolerance for pain like you have to and when positions are going against you.

CARSON BLOCK: I mean, you, you, that’s, that’s gonna be the norm a lot of times and you have to learn number one not to live and die with every tick of a stock.

CARSON BLOCK: And especially for those of us who openly publish our, our work, the journalist investors, that one’s hard because we’re, we’re so public on a name and especially there’s a lot of controversy around it and that, you know, every day it goes up, the, the people on the other side are basically, you know, they’re on Twitter, you know, egging us on touchdown dancing and you have to be able to, you have to be able to handle it.

STEPHEN CLAPHAM: And how do you, how do you handle that because people are taunting you. I mean, how do you keep calm and not get sucked into the argument?

CARSON BLOCK: I mean, you know, in the, in the early days for the first several years, maybe more, I’d say probably up until 2020 I generally try to be classy about it. And when we won, I didn’t touch down dance back on guys who were doing it all the time to me every day, the stock went up. But 2020 something kind of changed. Some things changed for me.

CARSON BLOCK: In terms of my, my mentality toward the business and, and life, I mean, on one hand with COVID and all of us being locked down, I felt that that imposed a layer of honesty and transparency. That’s many ways lacking from just how we in the investment industry present ourselves. And it was liberating in a way because here I am sitting at home like everybody else.

CARSON BLOCK: But I said, you know what, I’m not gonna put on a suit and tie and, you know, while I’m sitting in a broom closet and pretend, you know, like, and while I’m really worried that my kids are gonna burst in and like start shouting while I’m on C NBC.

CARSON BLOCK: Like, I’m not gonna do that, you know, I’m gonna dress the way I normally dress. And so I generally, so I, most days I wear a T shirt, I’m wearing one now. So I, I, I dress, you know, so I started dressing down a lot. But I also, I just also felt like the world is falling apart, like the world is burning and there’s just so many horrible things happening and you know what, I’m just gonna give my ID some more license here.

CARSON BLOCK: So when guys who have fucked with me, when it, when it finally, when the stock finally implodes right back at you now, I don’t know if my therapist would say that’s healthy. But, I don’t know.

CARSON BLOCK: I just, yeah, I, I think, you know, for everybody who does this, you know, just do what you just do what you feel like in, in that sense. I, I used to be, I used to be really worried that, oh, you know, this will reflect so poorly on me. And you know what if you know, reporters see that, I’m, that I’m tweeting this and you know what? I don’t know, man, at some point I stopped caring.

CARSON BLOCK: So, you know, that’s so, so sometimes it helps. Sometimes I get a little childish in response. I don’t, I don’t start these things. At least I like to think that I’m not the first one to go there. But you know, you just, we’re all human and you know, nobody’s, nobody copes with this perfectly and you just, you know, like just sometimes you have to give in to your, to your base or desires in, in this business.

STEPHEN CLAPHAM: It’s funny, it’s funny this term, which is new to me, the investor journalist because I was thinking there’s a big overlap. I saw Dan mccrum last week, you know, the F T guy that did the card. He’s such a nice guy, brilliant storyteller. He, he was on the podcast, I think three months ago and you know that that was such a traumatic and extended experience for him.

STEPHEN CLAPHAM: But you know, he relies and people like him rely on tips from conventional short sellers. And you know, John Hempton, the Bronte Capital Australian hedge fund manager gave him the original tip about wire card and then Leo Perry of Ennismore partners.

STEPHEN CLAPHAM: I don’t know if you know that firm, but in, in London met him in a coffee shop and give him more ammunition. And in the, if you think back to the old days when Jim Chanos was short of Enron, I mean, Twitter didn’t exist, there wasn’t a way that he could disseminate the, the information. And today short sellers and the people on the other sides are all over Twitter, which makes it a very different kind of arena.

STEPHEN CLAPHAM: I mean, the, the, this thing with, with journalists, I mean, I get quite a lot of interaction and I find it quite interesting because I’ve got some good contacts that are quite senior in London and they’re meeting with chief executives of companies and the companies are, are whispering in their ear about their competitors, you know.

STEPHEN CLAPHAM: So I get quite a lot of that feedback. I mean, do you, I mean, do you have a good relationship with obviously a big community in, in the US? Right. Are, are you competing with the investigative journalist to, in, in a way it’s a good question.

CARSON BLOCK: So I, I generally have a good relationship.

CARSON BLOCK: I think sometimes we’re competitors and, other times, there’s other times we’re not, but maybe we’re not to the extent we’re not. It’s because market because people perceive us, given that we are putting investment risk on as being different from an investigative journalist.

CARSON BLOCK: Now one thing that I, I do, I think some journalists chafe I’ve been telling them this privately for years that we are investigative journalists. It’s just a non-traditional model, nontraditional media. Some, some of them genuinely chafe at that and they say, well, you have a financial interest in the outcome and therefore you’re, you’re not, you’re not objective.

CARSON BLOCK: All right. Well, look, William Randolph first didn’t become so wealthy by not having a financial interest in the reporting. Now, maybe it’s not a direct financial interest in each story. But the reality is that the financial, the financial investigative journalism business is almost completely mound.

CARSON BLOCK: There’s so many stories out there to be investigated and journalists don’t get the time to do it because everything needs to be click bait. And that’s one of the things that I’ve, I’ve noticed and it frustrates me and my interactions with media.

CARSON BLOCK: How sometimes I’ll do an interview and I want it to be taken seriously and instead they just turn it into some bullshit click bait headline about crypto, which I always tell them, I don’t care about crypto. I don’t know much about crypto, you know, but if you really need me to talk about crypto, then I’ll say a lot of its scammy and boom, there’s your headline.

CARSON BLOCK: So, but yeah, the, the journalists just don’t have the money and time to do this work anymore. It’s not a good business model. So I think the only business model that support that actually pays for investigative financial journalism is married to a fund that is taking short positions.

CARSON BLOCK: Now, the F T or another large publication every now and then they’ll look at it as a loss leader. You know, this is good for us in terms of prestige and they’ll, they’ll let Dan, you know, run with the story and the F T is fantastic.

CARSON BLOCK: I mean, I, I think, I mean, by far the best in the world or at least the Anglo Phonic World at, pursuing investigative financial stories. But they are the exception. And even, and even then when you read Dan’s book, you’ll see that there that there were issues with bureaucracy and legal considerations.

CARSON BLOCK: And the nice thing about what we do as journalist investors is we bake all this in, you know, we say, ok, well, if this, if this goes according to plan, like my, you know, we’re gonna generate an expected P and L of blah. Ok.

CARSON BLOCK: So if I know that on average, it’s gonna cost me half a million dollars to get rid of a harassing lawsuit, then, you know, I make this decision. Is it worth it? And we expect to get sued? I mean, we don’t like it, but we expect to get sued and your traditional media outlets for this sort of thing really don’t want to get sued.

CARSON BLOCK: I mean, they spend their time, they spend a lot of effort assiduously trying to avoid being sued. And so I would argue that one of the advantages of our model is that we remove a lot of the fear from, you know, from the fear of litigation and so we can really, you know, be balls out when we, when we have these stories.

CARSON BLOCK: So, but at the end of the day, I mean, there are, there are, you know, also differences like we can’t talk to any, we can’t get M N P I material, nonpublic information, right? Like if you’re gonna be trading the stock, you must avoid that.

CARSON BLOCK: A lot of Dan’s later reporting the reporting in 2019 that really, you know, inflicted the fatal wounds on wire card came from a company insider. I mean, it would have been material on public information, had somebody traded on it. So that’s an advantage that the traditional journalists has.

CARSON BLOCK: But as I said, for us, the, the advantage we have is that we don’t care about being sued and so we can layer in opinion more liberally than a, a news reporter like Dan can. So we, we combine the, the actual factual reporting with commentary.

CARSON BLOCK: So look pros and cons. But, you know, I mean, if you compare the models except the end of the day, you know, the nobody makes money outside of trading, nobody really makes money on this type of work.

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STEPHEN CLAPHAM: It’s, it’s interesting that you, you say this because I was asked to write a piece for a major newspaper over here, a little while ago and I wrote the piece and they, they, the editor came back to me and said, have you checked this with the company? And I said, no, I mean, it’s completely my opinion, right?

STEPHEN CLAPHAM: So the company was completely, you know, misrepresenting its earnings and the lawyers at this, I mean, big newspaper insisted that they got the company, the company, they, they gave the company an opportunity to respond. So I said, well, you know, you got, I’m not going to you if you want to do that, that’s fine. Go ahead.

STEPHEN CLAPHAM: And the company came back, the company’s lawyers came back with such an aggressive response that they decided not to publish. And I’m like, what, what are you, you, are you a newspaper or are you a bunch of wimps? I mean, you know, you’re a major newspaper.

STEPHEN CLAPHAM: The company naturally disagrees with my opinion because I’ve said its earnings are made up. I was given an argument. Why can’t you publish that? It’s my opinion. You know, it’s no, you know, I’m allowed to have an opinion. You can’t sue me because I, my opinion is wrong.

STEPHEN CLAPHAM: They might argue that it’s wrong but they can’t, you know, I’m not making any debt, it’s not defamatory. It’s in my opinion that their earnings are mistaken.

STEPHEN CLAPHAM: And I was amazed, I was amazed that the, do you think there’s more of this that the, I mean, obviously in the United States, it’s always been a very litigious society and business obviously will seek to protect itself. But I mean, my perception is that there’s more of this today than there would have been 10 or more years ago. What’s your feeling?

CARSON BLOCK: Oh, I think that’s definitely correct. And it’s interesting that you’re, you bring up the US versus other jurisdictions in the US. Of course, we have the first amendment.

CARSON BLOCK: So it’s very difficult for somebody to actually, you know, public figure, which public company is to win a lawsuit, for defamation, they have to show what’s called actual malice, which is that the publisher knowingly stated a material falsehood or was reckless with respect to whether it was true or false.

CARSON BLOCK: Now that, that said, it’s, it is very litigious here and companies are suing a lot more and for guys who’ve been in this game longer than I, I mean, I, I didn’t get into this publicly criticizing companies until 2010.

CARSON BLOCK: But I’ve heard, I think Herb Greenberg and Roddy Boyd say that they think a lot of this goes back to Patrick Byrne and Overstock Dot Com. And he went over when he Overstock ended up suing Mark Cohodes Fund.

CARSON BLOCK: They were short and sued a firm called Gradient Analytics that had written research that was not published openly, but it was sent to their distribution list and it never went to a verdict.

CARSON BLOCK: The, the defendants ended up settling. But the, you know, the, the feeling that if I remember correctly, it’s Herb and Roddy have is that this really opens the floodgates to, to going after the critics and it really picked up steam in the last, in the last several years because, and, and this, this, this dovetails with my feelings about the information environment.

CARSON BLOCK: It used to be and a lot of times I think institutional investors used to say, look, it’s a distraction to sue the short sellers. I’m wrong. The company, I think they’re wrong. I think they’re a bunch of, you know, horrible people. But it’s a distraction, don’t do it.

CARSON BLOCK: And the, the reality is companies that really do have issues that where the critics were correct. They don’t want to get into discovery. But I think that the I, I think that show that shareholders expect far less restraint now. And maybe that’s also a similar phenomenon to what I’m telling you that I’m less restrained in responding to my critics publicly.

CARSON BLOCK: But, I think that, you know, one of the things when I look at the long side and I think it really started around 2013 where I’d say that alongside investors who cared about risk and try to avoid, companies that they saw as unduly risky were not remunerated for that.

CARSON BLOCK: And it was the, it’s been, you know, until 2021 it’s been the investors who basically are willing to, you know, like dive head first off the off the high dive effectively, who’ve, who’ve made the money and if they don’t give a shit, you know, like it’s a great story buy and I think that for those, for those people too, that’s, you know, like the, if they don’t care about risk, then, yeah, go ahead and sue these guys.

CARSON BLOCK: They’re pricks, you know, they’re costing me money. So, yeah, sue them. So I think that that there’s been a, I feel like there has been a mentality change among the institutional shareholder base for a lot of these companies as well. But, you know, the, the, the thing is, it’s also as far as getting comments from companies beforehand.

CARSON BLOCK: When I started this and or soon after I started this in 2010, that’s when I met Andrew left of Citron Research and I sat down with him and just hearing his perspective and one of the things he said is, he’s like, look, I don’t go and ask the companies, you know, hey, what do you think about this?

CARSON BLOCK: Because you know what the companies speak all the time. It’s called quarterly reports, annual reports, press releases, et cetera. They talk all the time. I don’t have to ask them and I fully subscribe to that view. Now, going back to the US and the First Amendment and it seems like it’s very protective.

CARSON BLOCK: One of the problems that we face is that we, I mean, I’ve, I, I’m always in litigation right these days. And it’s that judges don’t really understand the First Amendment. It’s quite hard. And so we saw there was another activist short seller or investor, journalist, journalist, investor.

CARSON BLOCK: I, I don’t know the guy well, but he he’d written under the pseudonym Roda for Roda for Tuna.

CARSON BLOCK: And he published on a microcap company several years ago called Farmland Partners.

CARSON BLOCK: So Farmland sued him. I don’t know, Farmland. I have never looked at, never, you know, even looked at the cover of its 10-K. And I only glanced at the cover of this guy’s report or the summary of, you know, wrote a Fortune’s report.

CARSON BLOCK: You know, probably directionally correct. I mean, just it’s a microcap company. There did seem to be some issues but he did fuck his work up. It seems like. So what ended up happening was Farmland Partners sued him, they sued him in Colorado Federal Court in Colorado. Probably not.

CARSON BLOCK: A judiciary that sees or a bench that sees a lot of first amendment cases and the defendant Matthews moved to dismiss and the judge ruled against the motion to dismiss.

CARSON BLOCK: And the judge in his, in, in his dictum stated that there is that there are factual assertions here that, that do give rise to an inference of actual malice and specifically what he was referring to what the judge was referring to that could give rise to actual malice is that when the, when Matthews emailed over a bunch of questions to the company, he stated that he would only accept responses in writing and he gave them, I don’t know, like maybe 24 hours in any event, the, the company offered to respond in a phone call and I, I, I can’t remember what they offered in terms of the timing, but the judge found this dispositive in terms of saying that Matthew’s conduct might have constituted actual malice because he insisted on the responses being and writing and within 24 hours.

CARSON BLOCK: And you know, by that same logic, then all of us are better off never asking the company questions, you know, like, OK, like that’s how you look at the First amendment, bro. That, that’s fine with me. We won’t ask any questions. So it’s, it’s a difficult.

CARSON BLOCK: And so with the net net, you know, Matthews ended up settling with the company and issuing or, you know, issuing a statement in which he noted a number of inaccuracies in his analysis and, and factual inaccuracies. And, yeah, those are what they are.

CARSON BLOCK: As I said, I suspect he could in some, in some way be directionally correct on this company, but it was sloppy work. But yeah, you got, you know, you got this adverse ruling, I think because, or he got this adverse ruling, I think because he asked the questions and the judge just doesn’t get first amendment.

STEPHEN CLAPHAM: It’s funny, isn’t it? Because 95% of South Side research is positive and I don’t know what percentage of it is sloppy, but I think probably a quite a high percentage of it, but you do negative research and you make a mistake, you’re much more vulnerable, which makes it a much more difficult business, doesn’t it?

STEPHEN CLAPHAM: I mean, it sounds to me like this is a really difficult environment because you’ve got this very litigious environment. You reminded me of the Tom Burgess book about the Kazakhstan company E N R C where the lawyers prevented them from publishing.

STEPHEN CLAPHAM: And he was fortunate that Wiley, his publisher defended themselves very vigorously and obviously at huge expense. And if you’re, you know, if you’ve got some oligarch just tells his lawyers, you know, just try and stop this and throw money at it.

STEPHEN CLAPHAM: If you’re on the other side, you’re, it’s really difficult. So this must make your business a really difficult business. I mean, aside from the, the, the difficulty of finding the targets and then executing properly, just the costs of running the business must be huge. I mean, you do, you get insurance, nobody would insure you muddy was right.

CARSON BLOCK: You know, we do have insurance but every year, but every year, every year the deductible gets higher, the premium get higher and the coverage amount gets lower.

CARSON BLOCK: And it’s, yeah, and I’m, I, I do suspect that we’re going to, at some point in the not too distant future, find ourselves in a situation in which we’re, we’re not insurable. But the reality is the deductible is high enough that, you know, they, that the insurance companies haven’t really had to kick in, to indemnify us.

CARSON BLOCK: I don’t think they’ve had to kick in to indemnify us in any litigations. Maybe I’m wrong. But, one thing that is nice about the insurance company is they will contract with certain law firms. So you get lower billing rates, from those law firms than if you didn’t have the insurer.

CARSON BLOCK: But yeah, it’s, you know, it, it definitely, you know, it’s, it’s definitely, you know, an issue in, in our business. And, I’ve, I’ve taken this view well, in terms of the, the defense, nobody knows this story. So this is the first time I’m, I’m telling it. And actually, it just happened very, very recently. I had a book deal.

CARSON BLOCK: So we had, there was a publisher wanted me to write to write a book not covering from childhood on but a consular Roman or Roman. Yeah, consular Roman. I don’t know what that means and I can’t even spell it for you, but in any event.

CARSON BLOCK: So I had this book deal, I’ve written actually a good portion of the manuscript but I had the, I had the agreement in front of me and you know, like some things got negotiated, but there’s this portion and I’m sure it’s standard in any author agreement. I mean, I, I I coauthored a for dummy’s book years ago in 2007.

CARSON BLOCK: So this was similar but basically this, this indemnification provision would have provided that I’m responsible for paying the legal fees. Like, yeah, I get it, but that the publisher would take the lead. They and their counsel would take the lead in defense.

CARSON BLOCK: And for me, that’s a no go right. Like I get sued all the time for defamation. I’m good at it and nobody lawyers me like me by the way. So I said, look, I’m happy to, I’m happy to pay the money here, but I want to retain counsel.

CARSON BLOCK: I want them to be lead and I’ll pay for your council to be like, you know, quiet co counsel basically, and that apparently has blown up this book deal. They, you know, they are at this point and no, go on that.

CARSON BLOCK: But to me that’s a key provision because I do know, I, I do understand what it’s like to get sued here and, and how to deal with it. And, you know, I, I, and it is such a litigious environment. So, yeah, I, I probably, you know, I probably fucked up my book deal because of my insistence that I handle litigation defense.

STEPHEN CLAPHAM: I wouldn’t worry about that. I mean, I think you publish a book. It’ll fly. I offer bookshelves, wouldn’t it?

STEPHEN CLAPHAM: We would love to read a book by you. I mean, I, I, I would, I will introduce you to my lovely publisher Harriman House who are British. So they’ll probably be less worried about.

STEPHEN CLAPHAM: I’ve, I’ve forgotten what the, what the litigation clauses in the contract where I was just, I was just so relieved that somebody offered me a contract that I just, I, oh, I’ve got a publisher now done. You know, I didn’t even, I didn’t even worry about that.

CARSON BLOCK: I wanna, I wanna, I wanna tell some stories, right? Like I wanna go because there’s a lot of my business that’s been public facing. And so I’m not just trying to retell what’s in these reports, you know, I want to go pretty deep and, and get into stuff I think is interesting. So, you know, like, you know, new potential plaintiffs perhaps.

STEPHEN CLAPHAM: But, but yeah, you’ll get, you’ll, you’ll be inundated with calls once the podcast goes out because all these, all these publishers will be listening to it, the American ones, maybe not so much. But, Harriman Harman who done really, really well. I mean, they’ve got, Morgan Housel book. I mean, they, they must be making a Fortune but, they, they will be able to get higher royalties than, than I did.

STEPHEN CLAPHAM: I mean, quite funny what, maybe just, change tack a little bit because I think, you know, a lot of people listening to this are practitioners. So we’ve got very, I don’t know what the percentage is but very high percentage of professional investors listening to this and serious amateurs listening to this and one of the things that they will want to know is how do you spot these things?

STEPHEN CLAPHAM: I know, I don’t want you to give away any of your secrets. And I doubt, I mean, to be honest, I doubt anybody could copy what you do because I know how detailed your work is. But have you got some tips for people as to what they should be aware, be wary of? I mean, or I know you’ve got some tips but what can you, what can you share?

CARSON BLOCK: Well after that build up about how this is, must be some proprietary secret sauce. I, I just feel like it’s gonna be massively disappointing. What I say, but a lot of it is what’s too good to be true.

CARSON BLOCK: Right. So you can look at that from a top down perspective. So what is, what is an industry or part of the market, like spas or E V spas that everybody’s excited about and where the money is flowing because when you have a lot of money flowing into a particular area.

CARSON BLOCK: Yeah, you’re gonna have, I mean, if it’s, if it were IP OS so pre 2020 oftentimes.

STEPHEN CLAPHAM: So this is the, the, the UK edition of the F T has got, can’t, can’t, can’t get his specs away. Yeah.

CARSON BLOCK: Right. Yeah, exactly. So, a lot of times, if we’re talking IP OS, yeah, maybe the third or fourth company to go public is those are the ones that are gonna be the real problems because they’re, they’re following along and trying to, you know, they, they’ve seen the success of the IP Os before them.

CARSON BLOCK: And so they’re not businesses that are really at that level, but they’re just gonna try to grab the money, kind of have a rule of thumb that anything with a market cap of one billion us on up that’s listed on aim is a fraud. So that’s, you know, that’s a great place to look.

CARSON BLOCK: But also if, if we’re talking about, you know, if we’re talking about in more micro level, I mean, companies that are highly, where the, where the managements are highly promotional and are promising the moon and where the stocks have been on a tear. So, in a way, it’s, it sounds really amateurish but it’s, it’s the, it’s the too good to be true angle.

CARSON BLOCK: And we’re not unlike a lot of other short sellers. We’re not running quantitative screens and, you know, because the, my view and I look, I I’m open to there being another side to this. But my feeling on screening is that you get a lot of false positives and false negatives because you don’t have the context.

CARSON BLOCK: And one thing that I think is really important to understand when I, when I talk to people about this is you have to understand what, you know, kind of what management would be trying to accomplish, like why they would be aggressive and where they would be aggressive. So a lot of things start out as basically an equity pump type of situation, right?

CARSON BLOCK: So we’re gonna, you know, we’re gonna do what we can to print growing, you know, rapidly growing earnings and, and, and revenue. So, you know what metrics, you first look at what management wants to show everybody. So what did they talk about in the conference calls? What do their press releases and their presentations focus on and when they start getting into non gap, non I F R S land?

CARSON BLOCK: Well, that’s what you look at and you really look to, you know, dig at it, especially when they talk about organic growth. I mean, my favorite is companies that talk about organic growth and they make a lot of acquisitions. I mean, they’re almost always screwing around with how they calculate that.

CARSON BLOCK: Often changing the methodology from period to period. And you know, they bury that in a tiny little disclosure, but when it’s an equity pump story, expect them to exaggerate on. Well, if, if it’s gonna be a problematic company, look at the areas that they’re showing the market, what they’re trying to get investors excited about.

CARSON BLOCK: Now, what often then happens if it goes on long enough is the company takes on debt, then it becomes potentially a different problem and maybe it was a great business when it started taking on debt. But now when you have a company where especially if they get, if they’re around that, that bottom rung of investment grade triple B minus that you always have to pay attention to these guys.

CARSON BLOCK: Then you start looking at, then you start thinking about them being really sensitive to credit metrics and messing with their leverage ratios. So you know what they I mean when you think about the leverage ratio of net debt over I Well, what are they doing?

CARSON BLOCK: Are they doing things where they’re understating the debt such as reverse factoring? Are they entering into a bunch of transactions? You know, that might effectively be depose near the end of the quarter to get some cash on the balance sheet. To knock down the net debt number, are they screwing with, you know, or operating income?

CARSON BLOCK: So there, there’s context there and that’s why I feel like screening doesn’t help that much because you really have to understand what’s, you know, what’s going on with the company and what and what they would be incentivized to do at a given point in time in terms of aggression.

CARSON BLOCK: So, yeah, a lot of times what we do, I say it’s very qualitative. A lot of it’s pattern recognition, you know, does, does this just when the, when the CEO is saying this on the call, does this make sense? I mean, one of our favorite things to do early on is to read call transcripts for several years.

CARSON BLOCK: And there are things that I look for when, when doing this. So first of all, is the nar you know, are, is management answering questions? Well, let’s actually back up a second. Do they use a lot of jargon and buzzwords that, you know, like you don’t know what they mean?

CARSON BLOCK: That’s always a sign then are there questions that they don’t answer? And this is one of the reasons going also back to that story I told about that short seller who got rung up in Federal Court in Colorado, one of the reasons why you don’t do this by phone is because it’s so hard in real time to understand whether they answered your question or just dodged it.

CARSON BLOCK: And you see this when you read call transcripts all the time, you know, you’ll see the confusion by the questioner and they don’t want to sound stupid or they don’t wanna, you know, maybe be confrontational on this call.

CARSON BLOCK: So they’ll just move on and thank them for the nonanswer. But looking at what companies refuse to answer or management’s refuse to answer is very instructive because that very well could be where, you know, one of the soft spots is.

CARSON BLOCK: And then are they, you know, you look at how promotional they are. And when they’re promoting, if you go back several years and you read oldest or, you know, the oldest to newest, are the, are there these initiatives, have they panned out or do they keep making promises or projections that just don’t pan out?

CARSON BLOCK: And if that’s the case then yeah, I mean, it’s, you know, it’s good chance it’s a problematic company. See a lot of what we do is really qualitative and it’s yeah, and we’re, we’re looking at, we’re looking at the statements and, and just asking ourselves like, does this, does this make sense? Could this really be true?

STEPHEN CLAPHAM: It’s interesting. I mean, the, the not answering the question is a very big tell, I think I put this in my, you know, I do this forensic accounting course for institutional clients. And we put in a section at, at the end where we talk about, you know, what are the signals before without even looking at their accounts. Companies give a lot of signals.

STEPHEN CLAPHAM: And exactly what you say is one of those signals is not answering the question, but I’ve noticed that very few companies do answer the question and I mean, I was reading the Netflix transcript the other the other week and I hadn’t realized, I mean, they get one analyst to ask all the questions and I’m like, what, what is that about?

CARSON BLOCK: I mean, that, that’s, that’s a tell also when there, when there are favorite pet analysts who are always called upon and when the language is obsequious, it’s always that though, I mean, great question guys, right? But you, but you have to ask, are there a bunch of other people who were in the queue who don’t get called upon?

CARSON BLOCK: And if that’s the case, you know, why isn’t, why is the company only calling upon the trusted pet analysts, the truly obsequious ones, you know, and that’s, I mean, that, that doesn’t tell you what they’re hiding, but that tells you that they’re nervous. Maybe I’m being, maybe I’m being naive.

CARSON BLOCK: Maybe my view is too old. I mean, I, I listen to far fewer calls than I used to because we’re much more focused as a business because we’re only doing a few names a year really. But, you know, back when I was on the long side and, you know, we cared about, I cared about a larger number of names.

CARSON BLOCK: Yeah, I, I’m, I’m sure the norms have changed on the, have changed on the calls. But, yeah, I, I think that a company that’s not afraid of being, of people seeing through it will call on analysts from the more, you know, some of the buy, buy side guys, definitely.

CARSON BLOCK: I mean, if they only call on cell side, that’s, you know, that that’s a sign. Actually one of my, one of the, one of the most fun things I ever did was years ago, we were short this complete fraud from China called N Q Mobile. And so they had this conference call.

CARSON BLOCK: The, the chairman had disappeared. It turned out that one of the other co-founders had kidnapped the guy and had held him for months. But so the rumor though was that the the Chinese government had arrested him at this time.

CARSON BLOCK: And so I had two phones, I had one phone where I dialed into the conference call as Carson Block Muddy Waters and the other phone, I took their their, their largest shareholder to Oberweis capital management or, or asset management. I said I’m Jim Oberweis Junior.

CARSON BLOCK: And so when they opened up the queue, you know, I hit the star or whatever on both of them and the Jim Oberweis phone got called on immediately and, yeah, Jim Oberweis Junior the next day pinged me and, you know, I think he, I, I don’t think he was serious when he said, ha ha, you’re pretty funny in an email.

CARSON BLOCK: Little, did he know that we had sent a, a pretty lewd Christmas gift to him that would be arriving later that day. And we did that because this guy had written publicly that we were stock manipulators in his newsletter. So, so anyway, it was just really a prelude to, you know what I, what I think was probably a, a frustrating day for him when he received the package.

STEPHEN CLAPHAM: So, part of the toolkit is to have two forms.

CARSON BLOCK: Well, I mean, it’s not hard to borrow somebody’s phone. But yeah, we as a matter of practice since almost day one, I’ve required everybody to keep their personal devices separate from their work devices myself included. And that’s just for I T security reasons.

STEPHEN CLAPHAM: But yeah, no, that Dan, was telling me about his trips in the tube. So he would, you know, get off the tube at the last possible moment. His bar card had investigators following him.

STEPHEN CLAPHAM: I, I mean, I mean, do you, have you encountered that, have you come across this sort of thing where, you know, a company’s reacted to you by appointing investigators and going through the trash and that sort of thing.

CARSON BLOCK: Yeah.

CARSON BLOCK: So I, I, the most, the most brazen example was Casino guard and the, it was obvious that they hired this guy named Jean Charles Brisard, to, to pretext as a Wall Street Journal reporter and it was so stupid and arrogant, which to me hits like, you know, couple of the big stereotypes of the French or at least the arrogance part.

CARSON BLOCK: But yeah, what, what this guy started doing was this is some years ago he started emailing my us pr agent or pr rep.

CARSON BLOCK: He said, I’m a William Hobin of the Wall Street Journal Paris Bureau and there is a real William Hobin who’s at the Wall Street Journal’s Paris Bureau, but he was sent, he sent this email from a Gmail account.

CARSON BLOCK: Now the first time we didn’t catch it, my pr rep didn’t catch it but he, you know, over time he kept sending follow up emails, you know, is Carson coming out with a new Casino report? And what’s the status of the AM F investigation into Muddy Waters and Casino?

CARSON BLOCK: And so with this Gmail address, it was always from Gmail. So we quickly had somebody reach out to the real Bill Hobin and that Bill Hobin confirm, I mean, he said, I I don’t even cover Casino. You know, we I did that person asked whether he’d want to interview me about Casino. And Bill Hobin said I I don’t cover Casino, not my beat.

CARSON BLOCK: So we knew that we had an impostor. And by the way, I was also pretty, I, I can be highly confident that one of these phone, one phone call I had with people in France around this time was electronically intercepted. So, you know, yeah, because I mean, basically I was talking to APR, a potential pr hire in Paris.

CARSON BLOCK: So I’ve been introduced to APR firm there in Paris. And I had my first ever conversation with the guy hung up and he said about 10 minutes later, his phone rang, it was a blocked number. He picked it up and the person said, oh, this is so and so from the AM F you know, the French market regulator and we want to, confirm that you represent Muddy Waters, ok?

CARSON BLOCK: No other way you know, of no. And so this guy was, you know, this guy, the pr guy had the presence of mind to say, why don’t you give me your name and number and I’ll call you back and he never got the name and number dude just hung up.

CARSON BLOCK: So clearly there was something going on there. So anyway, you know, a few years later or a year or two later, this guy Jean Charles Brisard. Well, you know, Bill Hobin emailed my pr guy and said, hey, I’m gonna be in New York. I would love to sit down with you.

CARSON BLOCK: My pr guy told me about this. Now, his firm, there’s no way they would let him take that meeting. But I said to him, all right, why don’t you ask him, would you like to meet with Carson? Carson’s gonna be in New York at the same time?

CARSON BLOCK: So he asked him and the guy said, yeah, that’d be great. And this was just maybe three days away. So I booked my flight from San Fran to New York. And I’m skeptical that the guy is actually gonna show, I, I just, to me this would be so stupid.

CARSON BLOCK: But lo and behold, he showed up and the best part is, you know, so I got this guy in video and I confronted him. I said, I know you’re not the real Bill Hori and he starts, well, he starts stammering, I guess up to that point though, maybe the funniest moment before that was right after he sat down.

CARSON BLOCK: Now, William Horrigan is British went to University Of Leeds. So this guy, his English is like, really, it’s really good, but he’s got the French accent. So, so yeah, when he sits down, he just kind of makes the small talk where he says, you know, I have been living in France so long as this, I have lost my British accent, you know, like no kidding, man.

CARSON BLOCK: Really? So, I mean, you, this guy thinks he’s, he’s fooling me, right? And, anyway, a moment later I confront him. You know, I know you’re not the real Bill Hobin. I’ve got guy on the balcony above me, I’ve got a bodyguard behind me. I’ve got an F T reporter at the table next to me.

CARSON BLOCK: Who didn’t come over at, at all disappointingly, you know, the whole fear of lawsuit, I guess, or whatever that we were talking about earlier. But, yeah, the guy just got up and left with haste at that moment. So I thought all right, this guy is probably just some low level schmuck, right?

CARSON BLOCK: Like he’s some guy who works for a bigger firm or maybe he’s an independent guy, but he’s probably just a schmuck. Anyway, I sent his image off to some people in France and when I landed, I, I received this, I received this cryptic email about needing to call as soon as I land and I did and I was told, hey, this guy is a really serious guy. Like people don’t want to talk about him on the phone.

CARSON BLOCK: His name is Jean Charles Prasad and he used to be with French Intel. Very serious dude. He’s one of the leading counterterrorism experts in France. And the guy had a Twitter profile and at the time, which this was a reasonable bit at the time he had 14,000 Twitter followers.

CARSON BLOCK: And really, you, you know, it’s like he thought that he could get away with this with a face to face with me with that stupid French accent. I mean, anyway, so that, that’s the most egregious situation I’ve faced. But I’ve been informed at other times that, you know, like I’ve had, you know, some global investigation firms hired to look at me, I assume they’ve gone through trash.

CARSON BLOCK: Yeah, and I’ve, and I’ve had, and the stuff that’s happened to me from people who’ve been trying to figure out what we were, trade, what we were gonna be writing on and trade ahead of that. I mean, that’s been just levels and levels crazier than, than, you know, the Broussard situation or anything I’ve dealt with from. Really? Yeah. Yeah.

STEPHEN CLAPHAM: I I, I went on yesterday with my modest following and, I said, you know, I’m interviewing Carson. I’m very excited. I, I thought, you know, I would reach out to fin and, and have you got any questions? And I, I, I got quite a few, but there are a couple very good questions. They were all good questions, but there are a couple that really interested me.

STEPHEN CLAPHAM: One person asked, what’s the actual sweet spot? Market cap range for shorts perception is many suitable candidates are too small or too large for an activist short seller. And does it differ by geography or by listing? Well, what, where where’s the best opportunity?

STEPHEN CLAPHAM: I mean, obviously there’s a, there’s an odd thing like card but that then presumably they’ve got more ways of fighting you and therefore it can be a more extended thing. So what without, and without giving away too many secrets. But there are, I mean, I don’t think anybody’s going to set up in competition to you, Carson, but there, there are no secrets to give away here.

CARSON BLOCK: Ok, so 11 thing that’s been, that’s been the case in the 12 going on, 13 years that I’ve I’ve been doing this is that market caps have massively inflated. So it used to be back when in 2010 to 2013, if a guy had a stock promotion or fraud and he could make $50 million off of it. I mean that put him at the big boys table nowadays, that’s, that’s like chump change, right? These numbers are so big.

CARSON BLOCK: And one of the results of that is that my behavior that previously was confined just to microcap space has migrated upward and you can find a number of companies that have, you know, market caps of a billion or, you know, somewhat more that are engaged in this truly egregious behavior. Now, I’d say for the vast majority of short activists, their sweet spots are sub a billion, definitely sub two billion.

CARSON BLOCK: So we are Muddy Waters. We’re among one of the few journalist investors that can swing a bat in the midcap space in the 2 to 5 billion range. So I would say for us, our sweet spots, 2 to 5 billion give or take, I mean, market caps are coming down but, you know, so maybe adjusted downwards somewhat.

CARSON BLOCK: But but by and large, you know, most of the people in this, in this industry are small operators, one or two people. And so they’ll focus on the truly egregious companies that are usually a billion or, you know, somewhere few 100 million to a billion in, in market cap. Now, that’s in the US Europe necessarily.

CARSON BLOCK: And this does include the UK still, unfortunately, Europe necessarily is different because you have this 50 basis point disclosure requirement. Meaning once you as a short seller are short 50 or more basis points of the outstanding shares, then you must you must report that and it becomes into the regulator and the regulator then makes it public.

CARSON BLOCK: So you can’t really, I mean, at least depending on, you know, what, what you have for capital, I mean, for us, we couldn’t do something meaningful for our capital at a billion dollar market cap because we get to what $5 million short before it’s public.

CARSON BLOCK: And we would prefer generally speaking to explain that we’re short and why we’re short rather than just having a regulator disclose the fact that money Waters is short. So that’s so Europe definitely is, is a different picture but that’s due to regulation.

CARSON BLOCK: You know, I think for traditional short sellers, yeah, I mean, it’s, it’s all, it’s all over, it’s all over the board. I think a lot of times it’s driven by what they have in a U M.

CARSON BLOCK: And if you are managing a multibillion dollar pool of, of capital, you know, you’re gonna need all the other things being equal to have large or short position and you don’t want to do the Melvin capital thing where you’re short a number of days of average volume.

STEPHEN CLAPHAM: It’s interesting what you say because it’s kind of like there’s a perverse outcome from the regulation. So this, this rule was put in to try and make things more open and transparent and it’s actually preventing the truth. You know, somebody like you investing in the time to bring the, the shine, the spotlight on the, the cheat. It’s funny, isn’t it?

CARSON BLOCK: Let’s call a spade, a spade. Ok. When they promulgated this, regulate, well, it’s really part of the law that’s, you know, mislabeled the regulation, market abuse regulation. But when they enacted this and they did not, when they, when they say they want these short sale disclosures to be public, they weren’t actually going, they weren’t actually trying to increase or improve transparency around short selling.

CARSON BLOCK: They were just trying to make it more difficult to sell short and they were giving companies an ability to discriminate against those who are short the stock by shutting them out of information flow once they’re publicly disclosed.

CARSON BLOCK: So, I, I, I don’t believe that for a second and, I think European European market, legislation and rule making, I think is, you know, when you read more, there are just various provisions that conflict with one another, others that are just highly subjective, you know, research must be precise, you know, like what does that mean?

CARSON BLOCK: You know, just a little bit of a digression but we once got a nasty letter from, the investigation, which is a department of the AM F and they accused us in Casino of violating more, you know, in every which way till tomorrow.

CARSON BLOCK: And one of my favorites that, that I remember was as a purported violation was that we were in that we were insufficiently precise because one part in the report, we were, we were talking about swap liability Casino had, we said approximately €500 million elsewhere, we said approximately €495 million and somewhere else, we said at €458 million and oh, sorry, 400 sorry, the €500 million 490 million, approximately 490.

CARSON BLOCK: And then there was like 4 €98 million. And so this is insufficiently precise, you know, could possibly be a violation of Mars.

CARSON BLOCK: So, yeah, so there are a lot of, I think unintended, I do think that the, as I said, the, the short sale disclosure I do think the true intention was to decrease short selling and make it less attractive. And, you know, congratulations guys.

CARSON BLOCK: But I guess the unintended consequence of that, you know, when you’re, when you’re dealing with somebody who wants to amass a large or short position is that, I mean, really, like, I think the way that everybody has to trade it is you get up, you know, you, you trade in at whatever your normal pace you end a given trading day at 49 spot, whatever five basis points short.

CARSON BLOCK: And then the next day you throttle it because you want to get as big as possible because you don’t have to report that until three pm, the day after the day after you hit the 50 basis points. So you just get as far over the line as you can in the next two trading days.

CARSON BLOCK: So it creates this since, since the, what I think the real ethos that’s guiding this regulation is that companies are delicate little flowers that must be protected against the scourge of short selling. You actually subject companies, I think to at least a couple of days of heavy short selling per short seller when you know, because of that 50 basis point disclosure threshold.

STEPHEN CLAPHAM: Yeah, I mean, well, you know, any regulation is gonna have some consequences around it. Another question on Twitter was how much work goes into each swinging?

STEPHEN CLAPHAM: So, I don’t know, how many positions you would have presumably, you don’t, you don’t have very many positions but you’re doing this sort of intensive work. But, I mean, typically how long would it take you to come up with a short idea and implement it? I mean, and how much time would it take?

CARSON BLOCK: Yeah, I mean, for us, I, I think the cycle time is, I mean, for us the cycle time is all over the board and we probably are longer than most, most in our business.

CARSON BLOCK: But if you had to pick an average call it three months, I mean, we’re out there maybe five times a year, sometimes it’s four, sometimes it’s six. But, we can get, we can get to a point within two or three weeks, whether we think something is a valid thesis and it’s actionable.

CARSON BLOCK: Ok. So the way I put it is if we were running, a long short fund and, you know, we were reasonably skeptical, on the short side, it takes us 2 to 3 weeks to get to that level of conviction where the people in that room would agree.

CARSON BLOCK: Like, yeah, this is a short, but what we need to do is we need to communicate with, to the longs and we need to convince the longs that the stock has to rerate. And so if the average cycle time is three months, basically all of that time from 2 to 3 weeks onward, when we’ve got internally conviction to three months is us preparing what we hope is an overwhelming case that we can bring public.

CARSON BLOCK: So it’s basically, you know, so it’s a much harder business from that perspective than just, you know, the traditional short selling model where it’s just, it’s so much more time and resource intensive.

CARSON BLOCK: Now, we do have a longer cycle time probably than anybody in, in this industry. But I, I like to think that’s because we’re doing the most complex names and we’re so thorough and going back to what I said earlier about always arguing me, you know, I always want to argue internally.

CARSON BLOCK: I will hate every short idea that’s presented and I will hate it throughout the process. And I will go at the analysts at times pretty hard poking holes in their research and, and I find it easy to do that because like I said, I enjoy, I enjoy showing other people they’re wrong.

CARSON BLOCK: But at the end of this process, if I can’t do that anymore, if I’m convinced, like everything I thought of, you know, it or that we’re gonna put in this paper, it’s locked down.

CARSON BLOCK: I have no issue then we’re good and, but that’s our process internally. And you know, I, I comparing us to other journalist investors.

CARSON BLOCK: I’ve often said, you know, we’re not, we’re not a fast boat, right? Some of them are pretty, some of them are pretty fast. Nimble boats. But, you know, we’re this big slow battleship that takes forever to turn. But when we turn, we have enormous guns and we’ll fire those. So that’s basically my mentality slash, you know, excuse for my managerial incompetence as to why we can’t turn things faster.

STEPHEN CLAPHAM: But it’s obvious from the, you know, I mean, the quality of your work is obvious from reading any of your stuff. But it, it, it, it’s really amazing. I mean, I, you know, I look at it, you know, you know, when you publish something, people really are set and want to want to hear it where I think for, you know, a number of the short sellers, there’s a lot of noise and not so much action or, or follow through.

STEPHEN CLAPHAM: And, I mean, sometimes and, and sometimes I suppose, I suppose the problem is that once you’ve invested a lot of time and maybe the share price hasn’t quite gone up as much as you’d hoped and borderline.

STEPHEN CLAPHAM: But you’ve got that much time invested. I think a lot of people just feel that they’ve got to push the button and especially if you’re doing it actively, then, you know, you’ve got that time invested, push the button, get hit the stock and then just cover your, cover your position. At least you’ve got a return on that.

STEPHEN CLAPHAM: That time. It’s, it’s, I mean, it’s such a difficult business. I mean, have you ever thought about just doing a long monthly fund. I mean, you obviously could do that. Right.

CARSON BLOCK: Yeah. Like I, I guess this is one of, of course, our critics will assert that we’re greedy and we own and we destroy companies just to make money. And the funny thing is my perspective is that I could have made a lot more money with a lot less drama if years ago said that we’re gonna do long oriented f or long short, I mean, God, like I could have gotten into, you know, China equities easily.

CARSON BLOCK: I mean, launched with, you know, blah 100 million years ago and just based said, all right, like, you know, you know, we’re gonna go along the, the harder to prove frauds and the guys who bullshit better and have fewer problems with their numbers and we’ll short the really bad frauds.

CARSON BLOCK: And I mean, fuck man, we would have been over a billion in a U M would have been well over a billion in a U M. You know, probably the guys who were, you know, in the China V C world, you know, who hate us probably would have been open to relationships, you know, because, oh, it’s Muddy Waters. They’re not gonna be our adversary.

CARSON BLOCK: It, it could have made so much easy money, I swear. And so that’s the thing that always gets under my skin when people are, you know, are critical of, you know, like accuse us of being greedy. It’s like, no, we do this because we enjoy it. We believe in it. We think it does perform some sort of social good. I mean, it’s not curing cancer granted but, you know, market cancers, it’s kind of trying to address those.

STEPHEN CLAPHAM: Absolutely. I mean, there’s a need for somebody to shine, shine a spotlight. I mean, the, the, you know, the interesting, the, the auditors, I mean, there are always people that, you know, investors, innocent investors look to, to protect themselves. And it’s extraordinary to me how limited their knowledge is. I mean, I’ve been in conversations with, you know, all the big firms over here.

STEPHEN CLAPHAM: In fact, one of the big, one of the firms is one of my clients are helping them, they’re trying to, you know, they’re trying, my, my client is trying to improve the quality of their process so that they don’t get caught in, in these frauds. I, I mean, have you got anything to say about the auditors? Anything that anything that we can’t, we won’t need to edit out?

CARSON BLOCK: I mean, I mean, I have lots to say but, you know, I, I think that, I mean, this is a profession that has its, has its cake and eats it too because they invest a lot of money in these global brands. And, well, the funny thing is, I guess just from a marketing perspective, it’s an interesting case study, right?

CARSON BLOCK: Because the brand is actually big four, the brand is not Deloitte or K PM. Nobody gives a shit, right? Like which, you know, oh, Deloitte’s so much. But no, they’re all, they’re all the same, but it’s big four. So collectively they invest in their individual brands to create this big four brand and they want that to have a lot of value.

CARSON BLOCK: And so they will charge companies a premium to use their audit services versus, you know, like non big four brands because of the implied greater trustworthiness and assurance that that audit provides. However, what they have done is they have structured their businesses so that they have quote these independent member firms throughout the globe that, you know, ring fence liability.

CARSON BLOCK: So up until the moment there’s a problem, people move throughout these structures without a problem. You know, the, well, the partner from, you know, the London is seconded here to Dubai. But whatever people move throughout these structures, money moves throughout these structures. The big four brand license stores make lots of money on this.

CARSON BLOCK: The global partners make lots of money from all of these individual members. But the moment there’s an audit failure, they, they, no, no, no, no, no, no, no, you can’t go after E Y no, no, this is the member firm you want in China that talk to them. And it’s just, it’s incredible that, that they get away with this. And but I guess there’s also look investors, investors themselves.

CARSON BLOCK: I mean, just have amnesia all the time. And how many God, how many debates have I had, whether on social media or, you know, it, or, you know, with journalists about a, a company where I, I’m calling it a fraud. Like, well, you know, they’re audited by Big four and, you know, big four firm wouldn’t risk its reputation.

CARSON BLOCK: What are you talking about? They settle all the time. They have all had major accounting scandals. Most of them have at least one a year and nobody cares. Nobody remembers. You know, they all, I mean, same thing with investment banks, you know, like people, oh no, no, no. You know, Goldman Sachs would never have done a deal if this come.

CARSON BLOCK: Why wouldn’t they have? Because you, you don’t remember you all you can remember is Goldman Sachs, right? Like you, you don’t remember what they’ve messed up. So, yeah, at the end of the day, a lot of the culpability is on the investing public for our just entirely predictable, too predictable, amnesia, collective amnesia about the, the various audit failures.

CARSON BLOCK: But yeah, it is to me repulsive how the industry, the audit industry has been able to create this structure where the Big four brand has all this value that they, they ring extra dollars or pounds or what have you from yet. They’re able to slough off liability on these small member firms at the end of the day and not really get punished. Materially.

STEPHEN CLAPHAM: So, listen, it’s been really fun talking to you. I’m looking forward for us having a drink at some point. I mean, I don’t know when I’m going to get to Austin, Texas, but hopefully you’ll be coming to London before too long. And I, I usually ask people and I, I, I profusely apologize, but I forgot to ask you in advance.

STEPHEN CLAPHAM: I usually ask people if they’ve got a book, they would recommend to a young person thinking of entering the industry. Now, I, I, I’m sure you’re not going to recommend any young person becomes a short seller because that would be, that would be unfair.

STEPHEN CLAPHAM: I mean, do you have any sort of favorite books that you would recommend to people?

CARSON BLOCK: Yeah, I actually, some of my favorite books are Financial Crisis books or when genius fails about the failure of long term capital management and the reason why and among the f Financial Crisis books, my favorites are Fatal Risk by Roddy Boyd and Crash Of The Titans, which is about Merrill Lynch, but all, all of them are, are great.

CARSON BLOCK: And the reason why I think that these are fantastic books is even though these are enormous companies. You see how the, the, the personality defects of CEO are can, can just be absolutely fatal to the business and how people view their incentives and disincentives and what actions or inactions those lead to. And so Yeah, when you, when you get down to it, I mean, Merrill, you know, crash to the Titans.

CARSON BLOCK: It was great. So they brought in Stan O’Neill and he surrounded himself with loyalists because probably, you know, the, the portrait that they painted of him was that he was generally insecure and he didn’t want anybody challenging him or maybe making him look bad. So he surrounded himself with loyalists. They had this one guy who was, and I haven’t read this book for years.

CARSON BLOCK: So I’m, I’m not super fresh on this, but they had this one guy who was in the, who was in the C L O business who had been promoted to, and been promoted to lead it and he’d previously just been a salesman and his responsibility also included some risk management and he was, and so, you know, but he was able to just keep stuffing Merrill’s balance sheet with these shitty loans because they were getting paid the origination or they were getting paid on these C L OS and figured like, yeah, you know, we’ll sell them out the back eventually.

CARSON BLOCK: We’ll securitize them even when the market stopped, just continued piling, you know, all this stuff into the warehouse. And there was a risk manager who had been kind of senior under the under the prior CEO his name is eluding me.

CARSON BLOCK: But, but O’Neill didn’t want to listen to this guy and you know, this guy is the one who stumbled across all of this risk in the book and is trying to get O’Neill to care. And o’s like, hey, shut up, right.

CARSON BLOCK: Like these were all very personal foibles that up to a point if they, if these have been, if these foibles had not existed within these people or, you know, if they, certain things have been addressed, Merrill might not have cratered.

CARSON BLOCK: So, and, and A I G is a whole, you know, separate series of pathologies there with with Hank Greenberg and, and brilliant guy, but he, he ran the whole company out of his head essentially.

CARSON BLOCK: So I think these are great for people to learn so they can understand because when you see these companies with large buildings and they’re global and they advertise on TV, and they’ve signed, you think of these things as indestructible for fortresses and the reality is no, like they, they can be very, very, very fragile if the people running them are fucked up.

CARSON BLOCK: And so, you know, like once you really understand that and you see some of the ways that, that various personalities in their, in their pathologies and neuroses can impact companies.

CARSON BLOCK: I, I think you have a much better understanding of the risk that you take as an investor.

STEPHEN CLAPHAM: It’s, it is interesting because it’s, it ties in very closely to what we teach on the forensic accounting course. One of the things is, you know, who’s running this and what sort of personality are they?

STEPHEN CLAPHAM: And exactly that point, I’ve not read that book, crash the time I’m going, I’m going to go and order it as soon as we’re, we’re finished because that, that is a very typical characteristic of people that surround themselves by yes men.

STEPHEN CLAPHAM: The trouble is it’s quite difficult to spot from the outside, which is why you do need to be on the inside. But listen, cos it’s been really wonderful. I’ve really so enjoyed talking to you. Thank you so much for taking the time. I really, really appreciate it.

CARSON BLOCK: Great. Thank you, Steve. I’ve enjoyed it as well.

STEPHEN CLAPHAM: Well, now, you know why Carson Block is one of the world’s top short sellers and why he is one of the few managers of a specialist short selling fund. Still standing. Muddy Waters does a huge amount of work in identifying, exposing frauds. And it’s one of the more difficult analytical skill sets.

STEPHEN CLAPHAM: I thought this was a fascinating explanation of a business which is essential to the honest operation of markets. And if you enjoyed this, you’ll be pleased to hear that we have more episodes planned on the area of short selling. Subscribe to the podcast to make sure you don’t miss them. Thank you for listening.

STEPHEN CLAPHAM: This podcast is aimed at serious and aspiring equity investors. I hope you enjoyed it. And if so, please leave us a review on Apple podcasts and please check out our other great content on the website behind the balance sheet dot com. Did I mention the free substack? Thanks for listening.