The global equity capital markets represent over a trillion dollars of market value being exchanged by investors around the world every day. Unfortunately this attracts people who seek to extract some of this money in any way they can, sometimes illegally or unethically. Muddy Waters (MW), a brand new website that was created by Carson Block on May 4 2010, put forth a series of scathing allegations regarding paper maker Orient Paper (ONP), disclosed at the same time that it is short ONP shares, that it will continue to trade in the shares including going long and that MW “makes no representation… as to the accuracy, timeliness, or completeness” of the information provided by MW. According to whois.domaintools.com Carson Block owns at least 20 other websites.
This author believes that MW’s allegations are an attempt to manipulate the share price of ONP for profit and are completely unsubstantiated. This article outlines these short-sellers’ format and modus operandi that they execute in unison.
MW’s claims about ONP follow a distinct pattern to another website that this author also believes comes from the shady corners of Wall Street. Waldomushman.com is a very similar website to MW that was created on June 28, 2009 by a person who posts messages on ONP’s Yahoo Finance Message Boards to the tune of about 10 posts per day on average and many more recently. Waldomushman.com also writes articles about small cap Chinese companies, though recently seems to have jumped on the MW bandwagon as all of his recent posts to the message boards are about ONP. Many on the message boards have speculated that waldomushman.com is actually Carson Block under a different alias although this author does not attempt to draw this conclusion.
The two websites waldomushman.com and muddywatersresearch.com both follow the same pattern of slandering Chinese companies. The formula these two website owners subscribe to is as follows:
1) Locate a company in China that has a similar sounding name to the Target Company’s operating subsidiary.
a. Show that this company reports less sales than the true operating subsidiary
2) Locate a company in China with a similar sounding name as the Target Company’s suppliers.
a. Show that this company reports less sales than the Target company claims to pay its supplier
3) Repeat steps 1 or 2 for the Target company’s customers
MW’s report refers to a “smoking gun,” which this author believes is step one in the flow chart above. It is copied verbatim below.
The audited 2008 PRCfinancial statements for He Bei Oriental Paper Co. Ltd. (“HBOP”, which is ONP’s China operating subsidiary) show revenue of only $2.4 million (RMB 16,320,687.26).16 (ONP claims in its SEC filings that HBOP generated net revenue of $65.2 million.17).
ONP management responded with the following:
The problem with this supposed "smoking gun" is that "He Bei Oriental Paper Co. Ltd." is not Orient Paper's China operating subsidiary. Orient Paper's China operating subsidiary is "Hebei Baoding Orient Paper Milling Co., Ltd". Even though the names may sound similar, "He Bei Oriental Paper Co., Ltd." is a very small paper manufacturer in Baoding and Orient Paper has no direct or indirect relationship with this company.
This author believes that these two website owners methodically choose their targets by low float shares outstanding, micro capitalization and high growth rates. These three factors provide the best opportunity to execute their cookie cutter research templates that follow the methodology described above. Low float and micro capitalization provide for the easiest price manipulation and high growth rates would be harder for investors to believe given the doubt they are expressing.
In the case of ONP, its management and board of directors, which include independent accountants placed on the board by U.S. investors in order to ensure the quality of reporting, have made public statements dismissing MW’s allegations. Further ONP has taken an extraordinary step in hiring a well-know international law firm, Loeb and Loeb, which it has instructed to hire Big Four Audit firm, Deloitte to respond additionally to MW’s claims. In this author’s opinion, a company committing fraud on the level that MW claims from would not hire a law firm and then hire a Big Four audit firm to check its own books. In fact, ONP would not even have the money to hire all these firms according to MW’s own claim that it overstates its cash balance as well.
Carson block, according to his LinkedIn.com profile, worked at WAB Capital. Through his articles, he claims that equity research is in his “roots” due to his experience at WAB Capital and that after running a storage facility in China for a few years he is qualified to report on Chinese manufacturing companies. WAB capital is owned by Carson Block’s father, and according to WAB’s website, it is run out of the father’s home in Los Angeles. Additionally WAB Capital, in its own description, is a paid-for-research firm. This means the issuers (or actual companies) must pay WAB to write reports. Interestingly this is exactly what ONP’s management wrote in its press release following the MW’s report. ONP management explicitly said that it was approached by MW to write paid-for-research report for ~$300,000 and ONP turned them down. Carson Block does not deny this himself, which leads this author to believe that Carson Block would have written a positive report if ONP had complied with the request for money.
Carson Block has no experience listed with any other research firm besides his father’s WAB Capital, which again is run out of a home in Los Angeles. The fact that Carson claims he went to law school and now owns a storage facility in China, leads this author to believe that Carson Block could not have accumulated enough experience in the realm of securities research to be writing such reports. The fact that his father is the owner of WAB Capital, which Carson Block claims represents his “experience,” is menacingly convenient as well.
According to his Linkedin profile, Carson Block does not carry credentials or licenses such as CFA, Series 7 or 63, which in this author's opinion is rare for someone claiming to practice securities research. If Carson Block was a member such organizations, this author believes he would be in ethical violations of their codes of conduct, which would include but are not limited to openly trading in the securities about which he writes (see disclaimer on MW’s website indicating they will continue to trade in ONP) and demanding money from issuers to perform research.
In summary, Carson Block published a report on his newly registered May 10 2010 website using what this author believes is a template for writing a highly negative report. These tactics include finding other companies in China that have similar sounding names to the Target firm’s operating subsidiaries and analyzing them to show fewer earnings.
Carson Block also owns 20 other websites, of which one I found is also an equity research website (China Primer Research). This author would encourage readers of this article to question why Carson Block requires multiple research websites, each with only one stock under coverage, instead of consolidating his reports, all of which involve small cap Chinese companies, under one umbrella.
ONP responded clearly that Carson Block analyzed the wrong operating subsidiary. The company has hired international law firm, Loeb and Loeb to conduct an investigation. The law firm has since hired Deloitte’s Financial Advisory Services group to respond directly to the MW allegations.
These do not seem like actions of a guilty company. However, waldomushman.com, a high frequency ONP message board poster, wrote the same scathing report using the same template as MW. The target company is currently trading at a $200 million market cap and recovered from the allegations, although the author of that report never recanted. So, I would not expect any different with regard to MW and ONP. These allegations will linger for some time and probably will never be withdrawn. It is simply how business is done in the shady corners of Wall Street.
Disclosure: Long ONP