The transcript from this week’s, MiB: Carson Block of Muddy Waters, is below.
You can stream and download our full conversation, including the podcast extras on iTunes, Spotify, Stitcher, Google, Bloomberg, and Acast. All of our earlier podcasts on your favorite pod hosts can be found here.
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RITHOLTZ: This week on the podcast, oh, I have an extra special guest. His name is Carson Block, and he is a — choose a adjective — brilliant, revered, notorious short seller. Say what you will about him. I find him to be an absolutely fascinating guy. I am a big fan of short sellers and have interviewed a number of them. I find the other ones who uncover fraud in all its guises often when various regulators are missing it. So, whether we’re talking about Jim Chanos or David Einhorn or go down the list of all the various short sellers, Carson Block clearly joins that pantheon of greatness.
He has uncovered a huge number of frauds. He talks about how China has allowed all sorts of fraudulent companies to go public, and then the New York Stock Exchange and other U.S. regulators allow these companies that are essentially shells with nothing really happening going on to be publicly-listed in the States where they manage to effectively steal money from investors. And he is absolutely blunt and vociferous in his criticism. He has uncovered a number of spectacular frauds that collapsed often to the point of being delisted publicly or, in another words, they just went bankrupt.
So, I found this to be really a fascinating conversation, and I think you will also. With no further ado, my conversation with Muddy Waters Carson Block.
VOICE-OVER: This is Masters in Business with Barry Ritholtz on Bloomberg Radio.
My extra special guest this week is Carson Block. He is the famed short seller who is the Founder of the research shop, Muddy Waters. They have about $260 million in assets under management. Some of the firm’s research reports have revealed extensive frauds at a number of companies, leading to stock prices collapsing and some companies getting delisted.
Carson Block, welcome to Bloomberg.
BLOCK: Yeah, thanks for having me, Barry. I’ve been looking forward to this, hoping to do it for quite some time, so glad we got the chance to connect.
RITHOLTZ: I’m glad we did. Thanks to Herb putting this together.
Let’s start with your background. And — and you have like a really intriguing background. You spent the summer of 1991 in Japan. Tell us about that. What did you learn about Asia from that experience?
BLOCK: Well, yeah, that’s — that’s going back pretty far. I — I don’t think I’d be here today if I hadn’t gone to Japan that summer. But every time I say that, the flip side is maybe I’d be running Goldman Sachs instead, so perhaps it wasn’t a great thing. No, I — I definitely kid on that one.
But yeah, I — that was summer after my freshman year of high school, and I had not yet been to a foreign country, so it was beginning of freshman year. And this history teacher who said that he would lead a group of students every summer to Japan to do an exchange, and that’s just so appealed to me. And people asked me, why don’t you want to go to Europe for the first time you go overseas instead? And I just make the joke that, yeah, Europe is the same as the U.S. except there are more bathtubs on lakes.
And yeah, I don’t know being in Asia and culture totally different really appealed to me. So, I went to Japan, and it — it, you know, was so different. And especially in 1991 and the — the bubble had just burst there, but this was a period in the U.S. where, you know, all the — a lot of the movies that were made the late 1980’s basically showed Japan’s dominating us. And, you know, every company has, you know, have the Japanese element to it now. And, you know, that — that’s kind of what was portrayed by the movies, and there is — it seemed like Honda and Toyota were putting Detroit out of business.
So yeah, it was — it was a really interesting time to be there. And I didn’t — couldn’t realize at the time that that was kind of the apex of Japan’s economic might so to speak, but yeah, really what my appetite for Asia.
And when I went to school or university a few years later, I wanted to study — I wanted to study Chinese, but my — my girlfriend who’s a couple years ahead of me in school, she was at Rutgers, she was studying Japanese. So, because of that and I’ve core studied Japanese for a year, but ultimately switched to Chinese, broke up with my girlfriend and, yeah, kind of set the course for the rest of my career.
RITHOLTZ: Yeah, so learning a little Mandarin certainly helped to go to law school and end up with Jones Day in their Shanghai office. Did — did the language help at all, studying the language or is it just so overwhelming for a foreigner that if you’re not fluent it doesn’t matter?
BLOCK: Yeah, that’s — that’s actually an interesting question because the thing is when I studied Chinese in school, so I took three academic years including a summer in Beijing studying, and just also to fill in some of the — the gaps.
I didn’t go to law school right after undergrad, so I graduated in ’98. And I — I’ve been interviewing for investment banking first year analyst gigs, but I also have this idea to start an A-share research firm in China, and I just couldn’t shake that idea. So, I’ve had an offer from one firm, and I was, yeah, still in process with others. But I just said to myself, you know, I probably always kick myself if I never gave this idea in China a chance, so I’d never know what would have been.
So ’98 graduated, got on a plane, moved to Shanghai.
RITHOLTZ: Wow.
BLOCK: I had no idea what I was strictly doing there. And yeah, within six or seven months I figured out.
I’d met with some companies. I made contacts in the market. I sat down with the PLA general who was running businesses for the PLA and was somehow involved in markets. And I just got this picture that I was probably 10 years too early that there was nothing I could say was investable or there would be nothing I could say was investable for probably a decade or so.
So, I went back to the States, conventional i-banking, worked with my father then in equity research for a few years covering micro caps. Had some embittering experiences vis-a-vis markets. And that’s when I went to law school.
So, when I entered law school, I didn’t think I would practice law. I was just there to get a degree, and I ended up really enjoying law school. So, I thought, Okay, I’ll practice.
And coming out of law school I had an offer to join Kirkland & Ellis in Chicago, but I also finagled an offer from Jones Day Shanghai, which the partner-in-charge of the Jones Day Shanghai office who’d given me the offer was advising me on a personal level. He said, “You shouldn’t come right out here to China. Just go and work for a few years in the States, and get good training and then come out.” But anyway, I ignored his advice, took the offer and ended up there.
So, to your question about language, and sorry for being so circuitous in the (inaudible).
RITHOLTZ: No, no, this is a very helpful background.
BLOCK: So, I met some — mostly American but, you know, non-Chinese lawyers in China who had always had a real passion for the language, and so they were near native and they’re speaking, and they could do documents draft and read in Chinese. For me, I could never get to that level because I never had a passion for the language. For me, it was always a tool that I wanted to put in my toolbox.
And the difference was these people had spent Friday and Saturday nights instead of going out studying Chinese and, you know, practicing. That was not me. So, it was — it was — it’s definitely helpful, but I was never, you know, in — in practicing law I was definitely helpful, but I was never somebody who got — you know, who — who would be able to handle the Chinese portions of a transaction. So …
RITHOLTZ: You weren’t drafting documents in — in Mandarin.
BLOCK: No. And a lot of the documents that we dealt with specially be involved foreign acquirers or foreign joint venture partners, a lot of those were in English and they would be translated into Mandarin. So that part was — that part was fine. But to do the — you know, ironically to do the due diligence and read-through the government filings and all these other documents that went to the Chinese — they often called them legal consultants because they didn’t have JDs from the States, so they weren’t — and they weren’t, at least at that time, accorded full associate status at foreign law firms.
RITHOLTZ: Quite interesting. So how do you go from being a lawyer at Jones Day in Shanghai to launching your own love box self-storage startup in China? How does something like that come about?
BLOCK: Well, like everything else up to this stage of my life in — in a very circuitous manner, what I actually — when I left Jones Day after not quite a year and a half, I actually intended to set-up a wealth management firm. And it was going to technically or legally be based in Singapore, but I was going to look to manage offshore, so non-China assets or wealth of Chinese entrepreneurs primarily based in Tier 3 and Tier 4 cities.
And kind of my thinking along these lines was they think with the offshore wealth they were looking for something that was less volatile, safer. And if I stuck to Tier 3, Tier 4 cities, I wouldn’t be competing with the bankers from UBS and Credit Suisse so much.
And I was going to be working with UBS. I was — was actually going to be the custodian of the assets. But anyway, I was in the process of setting that up. During that time I co-authored “Doing Business in China for Dummies,” which was really a foreign direct investment primer. You know, I think the “for Dummies” title really gives it short shrift.
But the — and that was a project that was in the works since before I left to move to China that time. But yeah, I was in the process of setting this firm up and two things were happening. You know, one, a good friend of mine was getting ready to launch a self-storage firm in Shanghai. And I introduced him to a family member of mine who had owned self-storage in and the U.S.
And when we sat down for dinner with that X uncle — he’d divorced out of the family — he said, “Of all the investments I made in my life, self-storage is by far the best. Over 17 years, 50 percent cash on cash return, and that doesn’t even include the land appreciation.” So now I’m thinking like, whoa, you know, and especially if we could be the first in China.
So, I decided I would be a passive investor, but a few weeks later that slipped to majority active investor. And eventually that turned into this guy needed me to buy him out. But that was — well, that was happening, I was also having doubts about whether I really wanted to spend my time hanging out with factory owners in Tier 3, Tier 4 cities because these are undoubtedly some smart people.
But, you know, I — I just had this vision. You know, when I first (inaudible) Shanghai, I had a real soft spot for — for animals, you know, and you just see them mistreated on the streets all the time. And I just kept telling myself, in addition to the just relentless drinking and karaoke, whatever, I mean, that’s kind of a euphemism there, but that I’d have to endure, then I would see these guys do some — something that, you know, really, really bothered me like I’d see just kind of pictured, I’d see a guy about to get in the back of his S class and you see a stray dog lying there and you go up and kicked it and left.
And I just — I just vision in my mind that just in there I would have to make a choice between sort of pulling it off or just being like, man, what are you doing? Like that is so wrong. And I don’t know why that was the image that kept going through my mind.
But when I — when I started thinking, on the other hand, about how self-storage could actually be — because it was going to be, you know, we were the one starting it in China, how could actually — it would actually be a near luxury service. You know, we were going for the Chinese who were buying Cartier jewelry or something, you know, and as opposed to it being the Joe Sixpack kind of service in the U.S. And we — we thought that we could actually build a strong, near luxury consumer brands in self-storage there as opposed to, you know, in the U.S. like nobody knows — can remember the name of their self-storage company because it’s so fragmented.
So, on one hand, the self-storage thing was exciting. And on the other hand, I was having genuine second or third thoughts about whether I wanted to manage that message wealth of Tier 3, Tier 4 factory owners. So, I decided, hey, this seems like fun and jumped in with both feet to self-storage, and that pretty quickly became unfun, but that was all part of the journey.
RITHOLTZ: So that leads to the obvious question from Japan to law school, to Shanghai, to self-storage, to — to writing a book “Doing Business in China for Dummies,” none of this has anything to do with short selling. How did this early experience color what was to come?
BLOCK: Sure. Well, I had grown up in the markets. My father was a — an institutional salesperson and equity analyst. He focused on high-growth micro-cap companies. I mean, earlier in his career he did early on McDonald’s, and I think even H&R Block. But as market caps increased across the board, what he focused on in dollar terms didn’t, so it kind of went from, you know, not ridiculously small to almost ridiculously small in terms of the market caps.
But, you know, he’s — he — he’s in an eternal optimist. He always — and I saw this consistently inside and outside the markets. He would see the best in people. And by the time I was in my early 20’s, I was starting to feel at times that there were people in my father’s life who took advantage of that and that he was often, you know, beguiled by charisma.
And what ended up happening, I mean, there were — there was an objective ways of — of — of measuring this, and that in — during the period of ’99 through ’02, we were being lied to and used by a number of managements of companies that my father, and then my father and I, we were had — had strong buys on or specular buys or whatever. I mean, we — you know, we thought that we were close with managements. And back then I think management insiders had 45 days to file their forms for.
And so, we noted some egregious behavior where we take management’s on non-deal road shows. I mean, some of our clients had come in and just buy the thing up in size, like I remember, you know, Fidelity was just, you know, way my father described it at the time a bull in a China shop, you know, the way they would buy.
RITHOLTZ: Literally.
BLOCK: But then we’d see these Form 4 or this Forms 4 that, oh, well, the CEO and COO just sold several million dollars’ worth of stock right after going on the non-deal roadshow while our clients were buying.
And it was one of my father’s precepts that he, quote, “put his money where his mouth is.” So, he was long all of these things personally in size, but he was recommending clients buy. And so, with my tiny little nest egg, I — I, too, was. And these companies started blowing up.
And I — I think the most egregious example was a company called Rent-Way, which actually wasn’t that small. I think was about a $600 million market cap at the time. And I developed a couple of institutional clients. I was, I think, probably 24 at the time. And so, we were taking the CFO Rent-Way on a non-deal roadshow.
We’re sitting in this conference room at this one client I developed, a reasonable sized money, you know, mutual fund manager in L.A. And the CFO, at that time, Rent-Way Jeff Conway looks my clients in the eyes and said to her, pointing at my father, “In the 17 quarters Bill has been following us, we never missed one of his estimates. That’s how good to handle we have on our numbers.”
But one or two weeks later, when my father was supposed to meet Jeff in New York, he wasn’t there and the stock was halted. And it turned out that, oh, my god, it was an accounting fraud. And old Jeff pleaded guilty, so did the controller beneath him and I think one other person.
And I don’t know. I mean, this was just salt in the wounds, but I think Jeff got sentenced a fewer years in prison and the people beneath them. But it was just this really embittering time where, you know, it wasn’t only happening to us, this was at the same time that Enron had happened, and WorldCom, and HealthSouth, Tyco. It just, you know, seemed like top-to-bottom. The market was filled with liars.
And I don’t know, you know, the other thing that my father had noted at the time was I was also quick to sell when my stocks had up. You know, I said, “Well, you know, like we were hoping for a 30 percent CAGR and I’ve gotten 50 percent nine months, you know, like hey, I’m out.” And yeah, I mean, like some of these things it was the wrong thing to do in retrospect. But I also had that — I had a very — I’m kind of just abuse the English language here, but it’s very risk-managey-type of mindset.
So, I think if you combine that with the bitterness that I was starting to feel toward the system and our packing order, which I as, you know, quasi sell-side equity research, I kind of started to view as at the very bottom. I wanted out of the market, but my father’s kind of one of his parting comments to me was, “Maybe you’d be a good short seller.” And I said, “Well, do you know any?” He was like, well, not really.
I mean, there’s this guy up in San Francisco named John Gruber who does some, but I don’t know, you can call him. And I said, “Nah, I’m going to law school.”
So that was — you know, that was really the background. And I’ll pause here but, you know, I — I — I was totally done with markets until, you know, by accident 2009.
RITHOLTZ: Let’s talk a little bit about what you were just saying about how 2009 and 2010 changed your life. You took a trip to China. Tell us about that. And I believe Orient Paper was the company involved.
BLOCK: Sure. Well, at the time, I was still living in Shanghai. I had this self-storage business, and it had a taught me many lessons, but one of them was that, as an entrepreneur, you really need to define at least as just beginning entrepreneur. You really need to define success as not failing.
So, what that means is I was struggling every day to not go out of business. And my father had gotten really interested in a number of these China-based companies that have gone public in the U.S. be a reverse merger. And he went to one of the Roth conferences and came back from that, really bold up about it.
And he was mentioning, yeah, we’re talking by phone and he’s mentioning several companies. And I — I’m — I’m sitting there in China struggling to keep his business from folding. You know, my wife and I were just kind of — you know, we joke about this period of time in our life, but it’s really not a half joke, but it’s really not a kind of joke, but yeah, we’re drinking pretty heavily, like every night was just kind of like let’s go — let’s go meet up with some other entrepreneur friends and I’ll numb ourselves to, you know, how badly we’re getting punched in the face every day.
And my father wanted me to look at or help him diligence some of these companies. And I don’t know, again I just wasn’t enthusiastic about this, but I — my expectation at the time and all — pretty much all the dominoes had fallen for me in the investing business at that point. I didn’t trust management, but I knew better than to trust bankers.
I — I realized — I’d realize that directors are, you know, incompetent, and lawyers are basically just there to serve the — the managements and they’re kind of weapons to use against curious shareholders. But I thought that auditors, I like probably 99 percent of the investing public thought that auditors were there to perform an anti-fraud function. And I’m not being facetious when I say this, but I know now that that is not actually the mandate. But I did not know that when my father brought up Orient Paper.
So, at this time in China, my life, I was quite skeptical of what went on in China, not only had I co-authored the book of “Doing Business in China for Dummies,” which involved a lot of great research. And not only had I seen a number of joint ventures and — and other direct investments go bad for foreigners, but I’d also chaired the American Chamber of Commerce in Shanghai’s Entrepreneurs Committee, and most of my friends were foreign entrepreneurs.
So, one thing about me is I’m pretty good at absorbing and internalizing experiences of others. And so, I guess, I was seeing the matrix at this point in China, but I didn’t quite know it yet. And my father wanted me to go look at Orient Paper.
So, I was thinking, Okay, here’s going to — the problem here if there’s going to be a problem, which there probably isn’t, but really the question is, is the guy stealing an unacceptable amount of money out of the company, I assume that the business would be real, that the profits could be largely real. But yeah, you know, using this too much for his own benefit, I think that’s (inaudible) investors.
RITHOLTZ: Wait, wait, let me interrupt you right here. An unacceptable — is the guy stealing an unacceptable amount of money in China? Is there an acceptable amount of money management can steal?
BLOCK: Yeah, I mean, this — this is a question that I remember my entrepreneur friends and I used to occasionally when we get together to numb ourselves, we used to discuss. And so, the question was, Okay, what do you think the average amount of money stolen is when the capital was provided by outside financing, whether it’s the government, a loan or equity investment.
In the consensus, like to a person, was if we’re being kind, 20 percent.
RITHOLTZ: Really? Wow.
BLOCK: Probably more like 30 percent in the case of something that’s good and functional. And so, we — we used to then laugh and apply that multiplier to the Shanghai World Expo. That was — that took place in 2010, and it was so funny because like Shanghai’s answer to the Olympics.
And Shanghai government bragged that it was spending, I think, $80 billion U.S. to prepare, so used to just laugh and say like, “Yeah, this is why Shanghai wanted this.” You know, it’s like if we’re being kind, $16 billion of graft, like that is so huge man, like foreign bank accounts and, you know, and apartments in Hong Kong are just going to be — like it’s going to be lit, man, like a few things are going — the money is going to be pouring in. So that was our view of what actually works in China is.
And I used to say at the time also that the difference between China and all of these other basket case EMs and FMs is, in China, they didn’t steal so much that they couldn’t build the road, like they understood the right level of corruption there, you know …
RITHOLTZ: Right. This is — this is the level of graphs that works best.
BLOCK: Yeah, they — they — they like optimized draft. So — so that was basically the question. You know, was — was Chairman Leo (ph) going to be on the right side of that line or was he going to be over the top?
And the first indicator I had that something could be really wrong was in the first conversation that I had with my father about it. He had just come back from this Roth conference, I think, in Florida and that’s where he’d heard about it and met some of the people around Orient Paper, you know, Americans, you know, promoter types and stuff.
And my father is telling me that, “Yeah, they say — they say Chairman Leo (ph) is different from other Chinese company chairmen. He doesn’t drink, he doesn’t smoke.” And my father is telling me that I just — I have this memory of being in my apartment in Shanghai. It’s late at night like I just really don’t care. But as soon as he said that, I perked up and I said — I was like, look, I’m sure none of that is true. But even if it were, the fact that this is what’s propagating at the conference gives me some pause because — and I told him this. I said this indicates to me that somebody is trying to game American investor psychology, like this …
RITHOLTZ: Right.
BLOCK: … is what we want to hear, isn’t it? He doesn’t drink, he doesn’t smoke. You know, and my father told me, “Oh, keep an open mind,” and whatever. And I said, “I will,” but this is already a red flag.
RITHOLTZ: So — so what did you find at Orient Paper?
BLOCK: Well, the first thing was I ended up having launched L.A. a few weeks later with the CFO and my father. I was back home for thanksgiving. And, you know, like all good China-based companies, the CFO sat in the U.S. and, you know, maybe flew over there like four times a year. And the company was about to raise money and reportedly build a — a new — new factory building with two new production lines.
I remember asking the CFO what I thought were some basic questions. Okay, well, what’s the — what’s the cost of the building versus the cost of machinery? I don’t know. Well, what do you anticipate the per square meter construction cost to be? Huh, that’s a good question, I don’t know. Well, about the actual machinery? Huh, that’s a good question, I don’t know.
It was just — you know, it was like this wasn’t a real CFO. And I could see through it. And then the real red flags came when I was talking about — I was asking about another anticipated investment that the company was supposed to make. They were supposed to be going to buy this photographic paper manufacturing line. And the CFO said, “Oh, well, actually Chairman Leo (ph) already bought it, and he’s holding it in trust for the company. And then the company is going to buy it from him. And I almost spit my lunch up. And I think — I think we’ve worked.”
What? You know, he’s selling it to the company. I mean, where is your (inaudible) …
RITHOLTZ: Well, at cost of cost, right? This is no market plan (ph).
BLOCK: Well, so that — so that — yeah, so that was one of the questions that then, you know, that was like maybe the second question was what did he pay for it. Oh, I don’t know, but — but, you know, we’re buying it at a fair price. We’re having it appraised by a third-party appraiser. Huh, Okay, what — like one of the Big Four or American Appraisal. Who’s the — who’s the appraiser?
I think it’s a local Chinese firm in Baoding. What? Why would it be a local firm and not a Big Four or — or American Appraisal or a firm like that? Because they’re experts in this type of — this type of manufacturing equipment. You know, and I’m just thinking no way, like this is — Okay, there’s — this is hyper, like this is corrupt. I knew that right then and there. But again, it goes to this question of is Chairman Leo (ph) stealing too much money or is it like, you know, would I still build the road?
So anyway, I said to him — the CFO at the end of the meal, I said, “Look, I’m happy to go up in early January. I’m going to bring a consultant with me who really understands manufacturing. And we’re going to take a much harder look at this company, your company than anybody else has before. I guarantee you that.”
So, if there is any reason Chairman Leo (ph) would have to not want us to look at the company under the microscope, just come up with an excuse. Okay? Just tell me, well, you know, something came up or whatever, all right and we won’t do it.
You know, and the CFO, like he just didn’t know what he was getting into. And he’s like, oh, well, no, I’m sure Chairman Leo (ph) would really look forward to that. You know, I’d want to know, too.
Well, he’s arrogant and it’s, you know, welcomed us to Baoding in early January of 2010. And what we saw was a Potemkin factory, I mean, a company that was about to report it’s 2009 revenue of 103 million. Best I was ultimately able to determine was — real revenue was only $2.5 million, $3 million.
And it was funny because I — I — I brought a consultant up with me. And I mean, this trip was just bizarre. But say it had on the balance sheet raw materials of $5 million. So, what — what Orient Paper produced is corrugating medium. So, when you look — you know, if you cut into a box and you see that wavy stuff …
RITHOLTZ: Right.
BLOCK: … inside the box layers, that’s corrugating medium. And that is made with old cardboard. So, you know, just thrown — thrown away cardboard, you recycle it, you make it in the medium.
So, they had on the balance sheet, I think, about $5 million of raw materials inventory. And with — at the — at the — the facility, they’re just big trash heaps there, just — you know, like, yeah, I — I don’t know, I mean, just to (inaudible) amount of trash heaps. And the consultant and I was with — he’s wearing like a, you know, Zegna overcoat and he climbs to the top of the trash heap, looks around, comes down and said to me, “If this is worth $5 million, the world is a much richer place than I ever knew.”
And I mean, it was just ridiculous statement after ridiculous statement. This equipment was, obviously, very old. I mean, if we were being generous early 90’s, it had — you know, it had like the typical state-owned enterprise slogans painted on it, so it was probably late 80’s vintage, but basically throw away from SOEs.
And it was being carried on the balance sheet. It’s I think like $60 million. They said that they had six lines, they were only able to show us two. The second line we suspected was actually not producing paper, but was just looping around finished paper. I mean, we couldn’t tell we are being very much rushed through the workshop at that point.
There’s water everywhere like on the folding tables. Okay, water is anathema to paper.
RITHOLTZ: Right.
BLOCK: Like that’s — you know, they just didn’t have the — the air handling equipment that a — like a moderately serious paper manufacturer would have. And there’s so many red flags.
And so, the company’s revenue and purported output had climbed significantly in 2009. And so, he asked the chairman — consultant asked the Chairman, he said, “So, Okay, you know, I’ll put last year was — was how many tons and, you know, it was pretty big, maybe 30, 40 percent increase versus 2008.” And consultant then asked, Okay, did you — did you add a production line? How did you — how did you do that? And he said, “Oh, process improvements.”
So afterwards, I think when we’re — when we’re downloading this incredible experience that we’re having and we’re — you know, and we’re talking about it, consultant said to me, it’s like, yeah, do you remember when I asked them how did you boost production and he said process improvements? It’s like, Carson, you were there. You were — you looked around. Did you see anything new like even a new mop or bucket? No, that’s total lie.
So, we — we realized, I mean, very quickly on on the visit that, no, this — it’s like this wasn’t a question of if the guy is stealing. It — it was a question of — it was really just — well, it was a conclusion of this is a Potemkin factory, this is not a real business. These numbers that they’re reporting are total lies. And …
RITHOLTZ: Right, it’s all fraud across the board. So — so what was your market cap and how large or short were you able to get off on that?
BLOCK: So, it was — it was $100 million market cap. And when I ended up publishing this report and it — like I — I didn’t get right into it because here’s the thing, I — I’ve gotten to China with pretty decent nest egg for a 30-year-old, but I had incinerated in self-storage, and I was now beyond that, like $200,000 in debt and climbing. I was borrowing from my father, so I had no money to short this thing.
And I asked my father, hey, you know, should we short it and put out a report. My father literally had never sold a stock short in his life, and he said he was not interested. And good luck to me.
Then I called some other people who I knew from nine years earlier so in the — in the markets and to see if they wanted to take a short position and somehow compensate me. And no, nobody was into that. So, I really didn’t have a model — a business model, and they just switched auditors to BDO Limited in Hong Kong. They’ve been audited by some Utah-based accounting firm that it would later turn out did not even have a valid PCAOB registration, but didn’t know that at the time.
But I figured, Okay, well, you know, this is like one of these probably like Chinese-organized crime met up with U.S.-organized crime, so it’s really thinking about this from the 1990’s market, you know, framework …
RITHOLTZ: Right.
BLOCK: … when I started growing up there. So, I think there’s no way they’re going to get unqualified audit opinion. Wrong.
So, in early April of 2010, I realized they had gotten an unqualified audit opinion. I’ve forgotten the company for a while because I just had, you know, no economic model here. So, I decided to produce a report that I don’t know would explain that this thing is a fraud, and I didn’t — there was no template for me to write this report. I just kind of made the — the template up myself the combination of what I used to write when I worked with my father and how I learned to write as a lawyer. And we researched it and disclosed that we were short.
Now, I was — I owned $2,000 worth of puts and that consultant also in $2,000 worth of puts. I funded that mine — from my credit card, and I think he basically done the same thing because he was — he — he owned a nascent factory in China that was never able to get off the ground. He was constantly embroiled in, you know, with (inaudible) with Baosteel, courtroom balls, et cetera.
So, at that point, you know, I didn’t really — my thinking was, hey, I’ve got nothing to lose. I mean, the self-storage facility like this thing is just a liability. What are they going to do? Take the liability from me. By all means, you know, you can have it.
So — and subsequently when I looked back on this, I realized there’s a real power in having nothing to lose.
RITHOLTZ: Sure.
BLOCK: So, I just threw the ball as far down the field as I could. And the one thing that I would hope for, I hope these guys would think that I had a sizable short position because I just — look, I knew I was confident I would win the litigation, but if they knew that I really had no money at all, they would have sued me anyway and just raked me over the coals …
RITHOLTZ: Right.
BLOCK: … you know, in terms of legal fees. So, I just — it was a leap of faith that I was going to be able to bluff my way out of getting sued. And (inaudible) …
RITHOLTZ: And what happened?
BLOCK: … so well, stock went down day after we published. It troughed off 55 — down 55 percent. Company came back. And so, my father and I had tried to extort them and they refused, then — you know, then when it was like, man, you’re — you know, because I was really nervous about that report to the moment I pushed the button. I mean, I knew everything in there was factual. I knew exactly what was going on, but I gut checked myself so many times because like it’s a big deal and going out …
RITHOLTZ: Right.
BLOCK: … and saying this company is — is a zero and they’re lying, but that nervousness entirely disappeared when they came back and lied.
I — I don’t know that I needed extra conviction. I mean, I didn’t, but the moment they started making stuff up about my father and me, then it was just like, you know, I mean, I — I was just like I’m bringing you guys down, like, you know …
RITHOLTZ: It changes the dynamics because suddenly they go from minor grifters with a tendency to exaggerate to, oh, you guys are just next level criminals, this is a zero. Your total frauds, and I’m going to double-down. Am I hearing that right?
BLOCK: Well, it went from somewhat, but it — it went more from fighting scared in a way to fighting with fury. And …
RITHOLTZ: So, it was a tell. They revealed that they were scammers, and they knew they were scammers, and they knew you knew they were scammers.
BLOCK: Right. And yeah, and then they started like lying about other things, trying to put the — the toothpaste back in the tube. And — but yeah, it was — you know, it was really — it was right after that that just, you know, I mean, the report went viral. And I had a lot of people reach out to me and say, you know, wow, great report, somebody’s finally exposed this stuff.
This is systemic. Look at this company, look at that company.
RITHOLTZ: Wow.
BLOCK: And I just sort of cracking open 10-Ks, and it was just obvious, you know, like all of these things that I was looking at, these things were frauds. I mean, it was just really obvious from the 10-Ks. I mean, I skipped over the part about us reading the Orient Paper filings before we went up there …
RITHOLTZ: Right.
BLOCK: … here in the airport waiting for a flight, and — and I mean, we just kept laughing out loud at different times, but again we didn’t get that this thing was going to be 95 percent plus lie. You know, that wasn’t apparent until we actually got on site, so yeah.
RITHOLTZ: How far did the stock ultimately fall?
BLOCK: I mean, the stock ended up getting down to below a dollar at times. I mean, that there was this back and forth, right, where, you know, they would come out with press release and stock could go back up. It had been 8.5 when we published, so then it was kind of range bound between four and six. And then when we did our second or did our second report or — sorry, report on second company Rhino International …
RITHOLTZ: Right.
BLOCK: … that company had the misfortune of making the mistake of the CEO admitting to the auditor that there were, quote, some problems with the contracts and the stock was very quickly delisted. So, after Rhino went down, I think Orient Paper sold off even more because the people who’d been skeptical of us were less skeptical of us.
RITHOLTZ: And validity to the prior reports, so now you have Orient Paper and Rhino. When do you say, “Hey, this is a real business, I need to form a company?”
BLOCK: Well, I formed a — I formed an entity at the outset before …
RITHOLTZ: Right.
BLOCK: … processing my first — remember, I was a lawyer.
RITHOLTZ: For — for legal protection, right, you want that shield.
BLOCK: Yeah.
RITHOLTZ: But when did you say I have a finance research business and potential hedge fund here that there’s money to be made betting against these companies.
BLOCK: Well, I — it was right after Orient Paper that I realized that. I came to the States for two trips, one of them was about a month. And at that point in time, I was trying to — by then I realized this is systemic with these China names. And I was trying to figure out what the business model would be.
Should we do consulting for investment banks that we’re looking to bring companies in China public? You know, pretty quickly, the door slammed in our faces. They (inaudible) diligence guys.
Then — then, you know, I was thinking, Okay, well, should I do this on a subscription basis? And I had — there was a company that sells, yeah, subscription research that was saying, yeah, look, you know, we’ll distribute a research and dadada (ph). And — you know, and I was looking at the numbers, I’m like, maybe, I could take this to, you know, a million or more in my pocket a year maybe.
And then there was also a very large hedge fund that said, yeah, look we want exclusive access to your ideas and, you know, we’ll pay you for those. And — but I kept coming back to this idea of doing it publicly and trying to have some — you know, if I could get capital to short these things and then publish.
And, you know, there’s a few — you know, this was a — this was a decision that took I know some time to make because I — I realized that that was going to be a much more — much more stressful pow. I will get sued.
Regulators — you know, I should assume that regulators will look at me skeptically every time we publish a report. But I felt like if I’m just providing subscription research to institutions identifying various frauds in China, I mean, one issue is how valuable is the research if these things never go down? I mean …
RITHOLTZ: Right.
BLOCK: … a fraud can flourish in the markets until the markets figure out it’s not a fraud. So, I did question the viability over the long-term of that business model. But the other thing was it just — I mean, it just seemed a little hollow as well because I felt like, hey, if I’m publishing this openly I can hold these guys accountable, right? But I’m just sending this to, you know, blah blah blah hedge fund for, you know, 50K a year from that fund. I don’t know who’s going to hold them accountable, like why would this matter?
So, based on that, I said all right I kind of, you know, like let me figure out a way to get some capital and then start shorting these publicly. And so, I made that decision, you know, I realized there was a business to do and that was the model I wanted to pursue. And I probably made that decision by late August to early September of 2010.
RITHOLTZ: Quite, quite interesting. Let — let’s talk a little more about what’s going on in China after that Orient Paper experience. You’ve called for many Chinese firms that are listed in the U.S. to be delisted. Tell us why.
BLOCK: They literally cannot be held — the people behind these companies literally cannot be held accountable. Not only that, they can’t actually be investigated. In that PRC law, that specifically prohibits any PRC-based person or entity from cooperating with an overseas regulatory investigation without the expressed prior consent of the China Securities Regulatory Commission, which in accepting the exceptional cases, it’s something like lock-in where the auditor already called it a fraud, it’s just not forthcoming.
So, you — not only can you not hold the individuals to account, you cannot investigate them. And I think Luckin is a great example here because Luckin raised, I think, about $800 million from the U.S. markets. And then the auditor after we — you know, we published somebody else’s research and said that it checked out to us, the auditor E.Y. confirmed that this thing was a fraud. And so, Luckin collapsed.
And — but the — the people Luckin ultimately settled with the SEC. And out of the $800 million that it raised from U.S. markets, I think it paid to the SEC $140 million. And that’s by far the most the SEC has ever gotten out of one of these China frauds. And the best part is Luckin raised that money with the bond issuance in China, I think, $150 million.
RITHOLTZ: That’s a good deal.
BLOCK: Sold the fund.
RITHOLTZ: You — you raised $150 million …
BLOCK: Yeah.
RITHOLTZ: … in bonds to pay for the fraud you perpetrated raising $800 million in equity.
BLOCK: Yeah. So, I mean, like I — look, I previously said, Okay, $140 million out of $800 million, that’s the biggest VIG (ph) any one of these guys had to pay in absolute terms in the percentage, and it’s not that bad of VIG (ph), it’s sub 20 percent.
RITHOLTZ: Still leaves you with over $0.5 billion, right?
BLOCK: Yeah, I mean, considering you stole the money, it’s not bad. But — but no, this — you know, these guys are better operators than that. But the — the — the issue — I mean, the reality is we just can’t hold them accountable. And so, when you have that system like — and so then also look at this, you know, some people say oh, you know, you’re a China basher, this and that, but the reality is China is an emerging market. China has a weak rule of law. China is a country riddled by corruption, both public sector and private sector.
And all — so all of these things are facts. And when the regulators in the U.S. don’t even have the ability to investigate, I mean, of course, these guys are going to come over here and lie and steal the money because why wouldn’t they. The proposition, if you’re sitting in China and, you know, and you got a business and I’m like you meet the right people who say, “Hey, you know, we can sex this thing up and, you know, bring it public,” blah blah blah, you’re thinking, “Oh, Okay, well, heads I win. Tails I don’t lose.” So why wouldn’t you go and lie?
And the other thing is that I — I think is more — the one of the changes that I’ve noticed in the 11 years that I’ve been doing this, back then when we first started publishing the Chinese guys we’re not sophisticated with respect to the market. They didn’t really get how things traded, and they — yeah, I mean, they — they got fraud, but the frauds were very crude basic frauds where you invent counterparty, invent customers and invent suppliers.
The frauds today mostly more sophisticated. They’re usually — there’s usually more reality to the businesses, usually. GSX is an exception. But they — they’re — but I — but I feel like a lot of these stocks are manipulated and are manipulated in very sophisticated ways.
RITHOLTZ: We’re going to circle back to that. I want to talk about some manipulation. But before we leave the SEC, however they responded to your urging that they delist firms that can’t be monitored or can’t even be audited.
BLOCK: Well, there was a bill that was enacted and signed into law by President Trump called the Holding Foreign Companies Accountable Act, and it provides that if companies in a country are not subject — if the auditors are not able to be inspected by the PCAOB, then these companies will be delisted within, I think, two years or, you know, two or three years after the enactment of the bill. And it was obviously targeted to China, but that’s the wrong issue to focus on.
China might — I’ve long held the theory that China would give on the PCAOB inspections because that’s not really going to be an effective anti-fraud tool just inspecting these auditors, like who cares. The PCAOB is going to be messed with during these inspections …
RITHOLTZ: Right.
BLOCK: … the same way. Everybody is messed with whoever goes over to check out a Chinese company. But — so I don’t know that we …
RITHOLTZ: Well — well, how do they mess with you? That’s — that’s interesting you say that. Let’s digress here. Did — were you harassed? Were you followed? Did you ever feel that you were in danger?
BLOCK: Oh, and so when I say — when I say messed with, I just mean fooled, and — and stymied, and stone walled. I mean, that — that’s what (inaudible) …
RITHOLTZ: No cooperation.
BLOCK: Well, it’s fake cooperation, right? Like that — that was the — that was the thing that was beautiful about most of these companies and still is. It’s — it’s the fake transparency because one of the fundamental problems the SEC has in one of these investigations anybody has is, first of all, everything is in Chinese so …
RITHOLTZ: Right.
BLOCK: … the vast majority of us in the U.S. and we work at the PCAOB don’t understand Chinese, and you need to translate it. Translation is incredibly resource-intensive, so it’s one thing.
I mean, when you look at it from the SEC perspective, the costs of these investigations are super high for them. And again, the recoveries and the probabilities of recoveries are so low, so that’s one reason. I mean, like genuinely, the SEC Enforcement Division hates investigating these China-based companies, but you do have the same problems.
PCAOB, very few of the people would speak Chinese. They be jet lag. They would have the Chinese Ministry of Finance people because it’s clear like that’s the only framework China would ever allow this to happen, shadowing them, being there. Documents will be switched out, would be missing. There’ll be all kinds of excuses like, oh, you don’t understand how it is in China, like this, you know, we have to give this document over here. Oh, let’s, you know, take these guys, you know, to the other side of town and see if we can find this document at the Ministry of Finance. Oh, no, it’s not here. Gee, guys, I’m sorry. Hey, how about we go and, you know, go to lunch and get drunk?
I mean, it’s like this is what I envision happening is that the third time would be wasted and they wouldn’t understand what’s going on. And like at the end of the trip, they would get back to Washington and just say like I don’t know what that’s happened, man, like I don’t know we were there, but (inaudible) …
RITHOLTZ: Wouldn’t it more effective to stay these are the minimum listing requirements in the United States, and if you don’t jump through these hoops, you can’t be listed here as opposed to going through that process. I mean, it’s a privilege to be listed here and you have to do X, and Y, and Z. Why not take that approach?
BLOCK: Well — well, I think, you know, the problem that we face, let’s be real here, Okay? I mean, my — my view is that almost all of the companies, if not all the companies listed in the U.S. from China are committing some level of fraud. They cannot be held accountable.
Now I think we could instead focus on this — this Article 177 of the amended securities law of the — of the PRC that went into effect in March of last year. And that is the article that expressly prohibits cooperation with foreign regulatory investigations into publicly-traded companies. That did not exist, that was not codified formally until the adoption of that — of that revision.
So before then it was kind of hard to — to say that, well, we — you know, we need to formulate a policy that says companies from China may not list here because we would, you know, it’s like, well, you know, aside from the fact that everybody knows …
RITHOLTZ: That’s too squishy.
BLOCK: … these things are committing fraud on a widespread basis like what can you point to in law because like in the U.S., you know, we’re really focused on like, you know, what’s the — you know, like give me a bright line definition of what may and what may not be listed. But now you have Article 177, so I think that any country that codifies a middle finger to U.S., you know, regulatory bodies in its law, a de facto should not be allowed to have its, you know, companies whose operations are substantially based there listed in the U.S. So, I think this was …
RITHOLTZ: That makes perfect sense, but — but I have to point out that it’s created an environment that has allowed you and your firm to come up with some spectacular short. So — so let’s quickly go over some of your greatest hits.
Sino-Forest, down 85 percent after your report. We mentioned Rhino, 67 percent drop before it was delisted. Tell us about …
BLOCK: Sino was delisted, too.
RITHOLTZ: Yeah. Oh, they were?
BLOCK: We have eight — you know, we have eight delistings globally, seven of which are from China, and I’m not including Luckin. We might be about to get our ninth delisting in France, by the way, (inaudible) …
RITHOLTZ: So — so what happens when you own a put and a company is delisted? What does that put worth at that point?
BLOCK: Yeah. Well, that was — that was interesting in the early days because these stocks should be halted for multiple months. And, you know, we had puts going into put expiry, and so you have to decide whether you want to exercise them or not. And we ended up — I mean, the one-time that’s really happened to us was on China Media Express, which was the third company on which we wrote would become the second delisting. And we had — we had puts that expired during the halt, so we exercised puts, but — and this happened to a lot of — at the — at the time I was using, you know, like retail investor talent (inaudible) a lot of retail guys at this time went, so we’re effectively short.
And the — the broker came back to us and said, “Oh, listen, you know, we need — we need you to deposit more margins. So, based on the last print of the stock, when this thing starts trading again, you know, you’re now short, you know, like blah number of shares that’s, you know, $500,000 worth of stock. We want 200 percent margin, so we need you to pump your account up, you know, store another $500,000 in there.
You know, like if — that actually — I mean, that actually screwed me up. I was very fortunate that I got — I got a loan from somebody who, you know, was — I mean — I mean, offered it to me just when I was lamenting. I wasn’t asking for the loan and — and so I was able to make money that way. But I think a lot of retail got shafted on those things.
And the other thing that was problematic was because when the stock — the — the brokers realized that once the stock started trading because there were all of these put options that have been exercised, everybody was going to be naked short. And so, unlike when you’re dealing with the institutional counterparty, you know, who would say like, all right, man, look, I get it, the stock is going to go down maybe after some initial volatility. Once it’s unhalted, you know, we’ll kick — you know, we’ll be chill and we’re not going to buy you in right away.
RITHOLTZ: Right.
BLOCK: We’ll wait until the afternoon to figure it out. But that’s how an institutional counterparty works. Retail …
RITHOLTZ: Right.
BLOCK: … counterparties were like you will be bought in as soon as it resumes trading so …
RITHOLTZ: Want to mention the broker who — who was so nice to their clients?
BLOCK: Oh, I mean, God, I can’t even remember — I mean, the — the — we weren’t dealing with Fidelity, but I heard — I mean, Fidelity was a nightmare. Fidelity was increasing the — the borrow costs during halts on all of these things. I mean, I think they jacked him, you know, from like 90 percent to 190 percent annually. So, Fido was sucking people dry.
I mean, I think …
RITHOLTZ: On a halt for a company about to be delisted seems sort of …
BLOCK: Yeah.
RITHOLTZ: … doesn’t really make a lot of sense to me. And you mentioned manipulation. Are you implying that for targets of yours like GSX or TAL Education, do you think the Chinese government are propping up those stocks?
BLOCK: Well, God, you know, what goes on behind the curtain, China is very difficult to say. And there’s also the lines between government, and government actors, and private sector actors are very blurry at times. So — but there’s just funky, funky trading in a lot of these things. And it wasn’t only GSX, a lot of other China names.
And then the final thing that I’ll say on this, nobody else I know talks about this, but I suspect that these companies water their stock all day long, and here’s how they do it.
RITHOLTZ: Meaning when you say water, explain that.
BLOCK: Well, that’s, you know, in the conventional sense, watering stock is issuing shares to, you know, people, insiders in their proxies, but without …
RITHOLTZ: Disclosing.
BLOCK: … without recording those shares that’s having been issued.
But what happens — what I think happens here that makes it so easy is you have to keep in mind that these companies are all domiciled in Cayman or some are BVI, but they’re — you know, they’re legally domiciled in Cayman or BVI.
And their shares don’t trade on U.S. exchanges. It’s their American depository receipts or American depository shares. So, what basically happens is if you have a Cayman share, you take it to the depository agent and it’s, you know, funged (ph) 01:02:12 — like exchanged into an ADR (ph) or ADS (ph) that may be traded on the exchanges.
But the question I’ve had is who the hell is keeping track of these Cayman shares that are coming to the — that — that are — that are being given to the depository agents. And look, I don’t know the answer because this is really are keen aspects of plumbing, but I suspect nobody. I mean, who’s — these are Cayman share registration. Okay, that’s — that’s the whole point of Cayman is that everything about Cayman-domiciled companies is secret specially to share registries.
What is their — I’ve asked some people and nobody’s ever been able to answer me what safeguards are in place that would prevent these companies from doing that or prevent the insiders from doing that. And so, I am of this view that our entrepreneurial friends in China are so entrepreneurial that, in many cases, not only are they completely lying about the financials of the company, but they’re also manipulating the stock and they’re also watering the stock, which is why would they.
RITHOLTZ: Meaning the share count is much higher than officially recorded.
BLOCK: Yes, or that the — yes, that the — the shares outstanding are — because I’ve seen in the past — I first started asking this question in 2011 or ’12 because I could see that the ADS counts were rising a lot faster than the shares outstanding, meaning the — the shares of companies issued.
And now that’s not unexplainable or that doesn’t in and of itself mean that there’s watering because as you have more legit Cayman shareholders, funds that are stock in the ADRs and ADSs to sell it, you’ll see that. But I just remembered noting that some of these increases — the deltas, you know, the ADS counts were growing exponentially and, you know, in the — in the shares outstanding, the Cayman shares weren’t growing that — that much. And that’s when it dawned on me, look, I’ve — I’ve lived in that country six years total, I’ve done business there. They are not going to stop just like — just committing fraud with respect to the financials, like that would be stupid. That would be leaving money on the table.
I mean, quite frankly, if this was the life you’ve chosen to be a crook of this sort, you would not stop at that alone. You would manipulate the stocks. You look — you would water the stocks. You would do every single thing you could do, and I just don’t think that you could get away with. And the mechanisms – look, one of the problems that we have with stock manipulation in the U.S. is that it’s so much stock trading is done algorithmically.
Okay, the SEC is staffed by lawyers and accountants.
RITHOLTZ: Right, not quants.
BLOCK: We need people who are NSE (ph) 01:04:53. We need people who have NSA-type (ph) skills to be inside the SEC to monitor trading, whether it’s China-based manipulation or — or just somewhere else.
RITHOLTZ: I …
BLOCK: That’s how manipulation occurs. And we — I mean, who’s going to — who — with those skills, you know, Stanford computer science graduate is going to go work for the SEC.
RITHOLTZ: No, not going to happen.
BLOCK: Nobody at this point.
RITHOLTZ: I — I never heard accounting fraud described as a gateway drug. It’s just the — the entry to — to more fraud.
One of things I found interesting about your background is your relationship with Jeffries Financial Group CEO Rich Handler. Tell us a little bit about how Rich Handler affected your career.
BLOCK: So, yeah, I — all right. Back in 2014, it was clear to me that we were going to go into the funds management business at some point, and we were having a problem finding institutional counterparties and — because, you know, we were so controversial. So, at that time and for a while after that, it was an annual ritual where Goldman would tell us like no.
And — and in late 2013 when my — I was in the delivery room, my son was about to be born, got the call from a prime brokerage sales guy at C.S. telling me that, well, the Reputation Risk Committee — something I never even heard of before — has met and said, “No, we’re — we can’t do business with you.” So …
RITHOLTZ: We’re going to go with this guy Bill Hwang instead.
BLOCK: Yeah, exactly, like — well, I mean, look, I even one time said to — you know, I — I had — I had (inaudible) 01:06:46 at a private bank that I’d opened with full knowledge — you know, the bank having full knowledge that I would be looking to do short selling — short sales in — in advance of reports. And so, well, yeah, that’s great, you know, and you get the same access to borrow as you get on the institutional side of the house. I mean, yes, it’s going to cost a little more but, you know, it’s otherwise the same thing. And then they decided after a little while that they were going to — you know, somebody in compliance was like no, no, we have to get rid of this account.
And — you know, and I said to my private banker at the time I was like, you know, because she was talking about, well, you know, we’re really focused on compliance now and then post GFC (ph). And I said, yeah, but we both know, right? And if I had a couple of $100 million, you guys will let me do anything I wanted, but whatever. So that’s the reality, right? Like that’s (inaudible) …
RITHOLTZ: So, what was the advice Handler gave you?
BLOCK: So, I went — so I — I set-up a meeting with him and, you know, I really didn’t — I didn’t know whether Japanese will be interested in doing thebusiness because they had a big — they were building their investment banking franchise in Asia. But I figure, you know, look, why not — you know, he — he took the meeting so, you know, that’s cool.
And, you know, he knew a little bit — he knew me by reputation, but he just started asking very, you know, direct questions like, Okay, well, I mean, this is a stressful business, right, like, you know, I mean — besides lawsuits, I mean, don’t you get that’s what C.I. do? You do. I mean, if you’re married and you got a kid at home, yeah, and, you know, and you just — and — and he’s just — you know, and I told him how, you know, like Goldman, you know, hated us and these other guys, you know, hated us.
And — and he just said to me he’s like — he said, “Why do you do this, man? You’re — you’re crazy.” And — and I don’t mean that in the ha ha, you know, funny way. I mean, really, why are you doing this? I think you’re addicted to the attention.
And you’ve got all these guys like Goldman Sachs and others with their knives out waiting to stab you in the back the moment that they can. You get death threats. We’ve got a young family at home. You know, you — you get lawsuits. You’re telling me you don’t sleep well ever. Why are you doing this?
Seriously, I mean, is this going to — at this point in your life — the kind of money you’re making? How much are you making? Is that — does that change your life? No, that doesn’t change my life. Why do you do that? And so, you know, he — and then again he repeated his assertion that he thought I was addicted to the attention.
So, I walked out of there. Yeah, look, I — I mean, maybe a lot of people say this, but I — I think I really mean it. I very much appreciate when people speak to me directly and don’t behest (ph) 01:09:31 me. I mean, assuming they have something valuable to say.
And I recognize that I just had one of those moments where a very smart sophisticated person who understands to a reasonable degree what I do was telling me that this was a bad life decision to continue — continue in this business. And I really had to pause and consider that.
And I did. I mean, look, maybe I told myself what I wanted to tell myself at the end of the day. I just agreed with his assessment, but I took it very seriously. And I even talked about it internally with — because at that time, my team consisted of some people who I considered close friends. I mean, it still does, but these are people who are friends first and then became team members. And so, I also felt like they were good people to help me evaluate what Rich had said and …
RITHOLTZ: How did you — how did you apply that? Did you go from pure short to long short? What — what did you do to follow his advice?
BLOCK: It didn’t really change anything I was doing. It wasn’t that I followed the advice, it’s just that I felt — I’m somebody who’s very focused on process and especially when it comes to making difficult decisions. And, you know, even if I don’t change my mind, I — I always want to get more information. I want to get contrary perspectives because I understand my decision better, and I understand the tradeoffs better.
And I just felt while Rich’s advice didn’t alter the outcomes and improved the process, and it helped me better understand why it is that I’ve chosen this as — as — as my path.
RITHOLTZ: Makes a lot of sense. So, I normally have you for a few minutes. Let’s look at 2020 and 2021 and see what’s made this past couple of years so — so challenging. Clearly, 2020, there was a brief collapse and then straight up the rest of the year. How challenging of the year was in on the short side in 2020?
BLOCK: Yeah. I — I really — I really hated 2020. And I mean, part of it is I — you know, I — I definitely have a hard time separating my — my feelings about the external environment from my, you know, feelings about what was happening business-wise.
You know, I — going back to a comment I made earlier about how I’m very good at absorbing other people’s experience. I think I’m — I think I’m very sensitive to the environment around me, especially very, very sensitive to risk and — and — and trouble. And so, 2020 was just a year of — I mean, it was emotionally overwhelming for me just based on all the misery. You know, I felt like my heart was breaking some — you know, more and more every day. And on top of that, business was, you know, like really, really hard.
So, we — I — you know, we were early — I was personally very early in the toilet paper trade in COVID. You know, I think it was like — or sorry, it’s late January when just stocked up on toilet paper and, you know, canned food and, you know, basically got ready to live in a bunker.
And it was at the end of February and markets in the U.S. hadn’t yet reacted. And also there’s an interesting point here because by late February, Hong Kong and mainland markets have largely recovered from there COVID dips. And we talked about the manipulation of the markets from China.
China developed the I.P. to manipulate its markets back in 2015. It tried to — the government had tried to novate the housing bubble, the real estate bubble into an equity bubble and pumped up the equity bubble, but they didn’t understand that those bubbles are harder to keep going because you’ve got daily mark-to-markets.
RITHOLTZ: Right. And — or marks to market. And anyway, but they — you know, at that time, they started throwing short sellers in prison or in jail temporarily. They got the brokerage firms to go out and buy stocks, and I think they were pumping money into the — the government is pumping money directly in the market to keep it propped up to send — to avoid the loss of wealth. But I felt like the same thing must’ve happened in February in China and Hong Kong because the government was trying to downplay — they were trying to cover up any signal as to how serious COVID really was.
So, the rest of the world was kind of in the malaise (ph) 01:14:29 at the end of 2014 where, you know, we’ve been anesthetized by 11 years of ridiculously low, you know, rates, so anesthetized the risk. And we’re looking at the China Hong Kong markets going, “This thing can’t be so bad, right?”
RITHOLTZ: Can’t be that bad.
BLOCK: Like those markets aren’t off.
And I knew at the end of Feb when I saw the results (inaudible) 01:14:51 Evercore surveyed institutional clients that they didn’t think that COVID would have — I think it was only, you know, relatively small minority that expected COVID to have a material impact on the economy and markets as like this is complacency. And so, at the end of February, (inaudible) like all these names we’ve looked at throughout the years that didn’t make the cut for activist short selling, but we know are crap companies. Let’s short these things. Let’s get CDS on cruise lines. Let’s do this, let’s do that.
And so, we had this great March. We didn’t even have to publish anything. And by the end of March, I think we were up net 11. And I’m — you know, and I’m — I’m thinking, man, this is going to be a record year for us. And we are so smug, right?
RITHOLTZ: Right.
BLOCK: At least I was. I’m sitting there going, yeah, you know, I’ve been doing all these interviews for all these years saying if you lever up your balance sheet to buy back stock, you are creating fragility. And now ha ha, all this fragility is coming home to — you know, the chickens are coming home to roost, look at you private equity guys having, you know, destroyed corpses of companies for, you know, a couple of decades, ha ha, joke is on you. No, it wasn’t. Joke is on me.
I think we’re the last to get the memo. It was like early August what I — what I’m saying like, Okay, all of these trades we put on at the end of February beginning of March are genius trades because we’re so smart. Dude, we got to get these out of the book. I think they were hanging there until August.
So, we — we — so we were getting — you know, we’ve given back, I think, almost all our teams on that. We’ve gone …
RITHOLTZ: Right, markets got back to breakeven in August from the pre-March collapse.
BLOCK: Right. And then we were also now riding losses from GSX, which we’d short in early June. Now we’ve done well shorting eHealth in early April. So that was — that was actually that was and is a great short, both in absolute terms and in alpha, but there’s GSX. And then we went into, I think, September with this really scammy company that, you know, normal times they have no business having a market cap anywhere near $1 billion, but called [Nanox] 01:17:07.
And so, we went short that with this expose as to how like this whole thing is just a promotion and, you know, there’s no reality there. And this thing closed up on us on the day and it kept ripping.
RITHOLTZ: Wow.
BLOCK: And so, we’re — you know, we’re getting bled out on [Nanox], we’re getting bled out on GSX. You know, our genius trades had — had (inaudible) …
RITHOLTZ: All painful.
BLOCK: Yeah, and it was tough. I mean, we — we really had the rally and we were getting ready to launch another fund. You know, I was in — in January, I was — I was just marketing this new fund to be intended to launch in, you know, early to mid-Jan — or so early to mid-2020, and we sidelined it because of COVID.
But by the time we’re — we’re bleeding everywhere in the summer of — of last year, I was just like, man, do not talk to me about this new fund launch. I do not care. We are in a nose dive. We need to pull out of it. And …
RITHOLTZ: So — so let’s talk about …
BLOCK: … I mean, we did.
RITHOLTZ: Yeah.
BLOCK: We did. I mean, we finished — look, we finished with a decent print for the year. Our clients were happy, but …
RITHOLTZ: All right.
BLOCK: … I just got really no — I got very little satisfaction from — from that year.
RITHOLTZ: So — so I want to jump to our favorite questions we ask all our guests. And Charlie will record the outros later. That’s easy enough to do. So, let me — let me plow through my speed round, and we have like three minutes for these.
Tell us what you stream these days. You know what, I’m going to hold off on this. I’m going to ask in the last two minutes we have, what do you make as some of the craziness that took place in the U.S. I was reading this morning that Michael Burry of the Big Short fame is short Tesla. What — what do you make as some of those crazy stocks, things like GameStop? And — and any thoughts on bitcoin?
BLOCK: Okay. So, I mean the mean stocks just show that the market just broke in May are a symptom, not a cause of the market being broken. The factors that have broken the market are the predominance of passive investing because that actually has a convex effect on price behavior and increases fragility.
It’s the amount of ridiculously low interest rates and excess liquidity, and it’s also the — the erosion of the rule of law and the lack of accountability that in — you know, in the markets and in society. So, these are factors that have combined to create this broken market. And plus, there were a lot of retail and, you know, retail market participants who came into the market last year who didn’t do it out of boredom, didn’t do it because they’re punching their stimulus check, they did it because they were trying to gamble their way out from underneath financial hardships that had been created by COVID. So yeah, so this is — this is a culmination of (inaudible).
RITHOLTZ: And bitcoin, what do you think of bitcoin?
BLOCK: I’ve got a friend who, you know, is kind of in this space, pretty smart guy. And he said that the — the real value of any of these blockchain-based cryptocurrencies is the present value of the transaction fees or the — I think he calls them the gas (ph) fees for using it.
Beyond that, he admitted — and he’s — you know, he’s got a real bitcoin position. Beyond that he admitted it’s just a tulip, so …
RITHOLTZ: Right.
BLOCK: … I don’t touch it, I don’t care. I’ve seen these — I’ve seen fads and the next thing to come and go like bunch of times during my career. And I’ve seen a lot of people who can’t tell the difference between luck and skill because they happen to be in the right place at the right time. And crypto bitcoin smell that way to me.
RITHOLTZ: Thanks, Carson, for being so generous with your time. We have been speaking with famed short seller Carson Block of the research firm, Muddy Waters. Carson’s hedge fund has about $260 million in assets under management.
If you enjoy this conversation, well, please check out any of the other nearly 400 prior discussions we’ve had over the past seven years. You can find those at iTunes or Spotify or wherever you get your podcasts.
We love your comments, feedback, and suggestions. Write to us at mibpodcast@bloomberg.net. Sign up for my daily reads at ritholtz.com. Check out my weekly column on bloomberg.com/opinion. Follow me on Twitter @ritholtz.
I would be remiss if I did not thank the crack staff that helps put these conversations together every week. Tim Harrow (ph) is my Audio Engineer. Michael Boyle is my producer. Atika Valbrun is our Project Manager. Michael Batnick is my Head of Research.
I’m Barry Ritholtz. You’re listening to Masters in Business on Bloomberg Radio.
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