Lessons from Carson Block

Carson Block, the founder of Muddy Waters Research, has carved a niche in the financial world as a prominent activist short-seller, known for his in-depth and often scathing reports on companies he believes are fraudulent or overvalued. His work has not only led to significant stock price declines in his targets but has also sparked broader conversations about corporate governance, due diligence, and the nature of modern capital markets.

On Short-Selling and Activism

On the nature of activist short-selling: "As activist short sellers, we tend to focus on shorting companies where there is usually an element of wrongdoing or misrepresentation by management, if not outright lying or fraud." [1]
The activist's burden of proof: "We have to be provably correct at the time we speak about our theses." [1]
The challenge of shorting deceptive companies: "From a traditional short sellers' perspective, our type of companies are the worst to bet against because when you have managers working to push the stock up and deceive investors, they can generally keep going unless and until somebody tells the market what is going on." [1]
The loneliness of the short-seller: "It's never been a good time to be a short seller I suppose." [2]
The activist's role in a broken market: "I believe that the US markets in particular are broken." [3]
On the necessity of activism in shorting frauds: "These days, you need to be an activist and say it is a fraud." [4]
The changing landscape of short-selling: Block notes that the rise of passive investing has made short-selling more difficult as the automatic buying from index funds can prop up even fundamentally weak companies. [5]
The personal toll: Block has faced lawsuits and investigations, acknowledging the intense pressure of his work. [6]
The motivation behind the fight: "These corrupt motherfuckers had brought their toys to the sandbox of the U.S. markets. I was determined. I'm going to mow you motherfuckers over. Because I know how your system works here. I know how to get information on you pieces of shit." [6]
The shift in the short-selling community: Block observes that many long-short funds have moved away from single-name shorts to index shorts after the meme stock phenomenon, highlighting the increased risks. [3]

On Fraud and Due Diligence

The limitations of audits: "Audits of public companies are not designed to detect fraud. Auditing standards presume that company documents are genuine and management does not make misrepresentations about their numbers." [7]
The fallibility of paper trails: "In today's world where you can buy a competent color printer for less than $200, it's hard to understand why investors place so much faith in bank statements, invoices, and contracts." [7]
The six rules of China due diligence:
- Rule #1 – Approach the company as a potential customer does.
- Rule #2 – Take all company-provided introductions with a grain of salt.
- Rule #3 – Try to construct your own fraud scenario.
- Rule #4 – Forget about the paper. Focus on the operations.
- Rule #5 – Always speak with competitors.
- Rule #6 – Do not delegate. [7]
On the prevalence of fraud: "Provided that there are capital markets, I think our profession will be as eternal as that of prostitution. You're just betting on human nature – the darker side of human nature. That's all." [8]
The simplicity of uncovering truth: "It's amazing what edge you can get when you just read." [7]
A healthy dose of skepticism: "Beyond all else, ask questions and never accept an answer at face value." [7]
On identifying red flags: "When you see significant insider selling, that is worrying, especially in cases when these executives hold large numbers of shares." [1]
The pervasiveness of some level of fraud: Block believes that a "substantial majority" of U.S.-listed Chinese companies are committing at least some level of fraud. [9]
The "real" level of fraud in some markets: "In China a company that invents 30% of its revenue is considered real...north of 50% is where they start to say yeah that's a fraud." [9]
The investigative process: "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." [10]

On China and International Markets

A transactional relationship with the Chinese market: "You date China, you don't marry China." [11]
The inherent risks of investing in China: "That's the kind of place you wake up one morning and you know oh they invaded Taiwan...you don't want to be long anything China related at that point in time." [11]
On Wall Street's compromise: "The government of China has co-opted much of the U.S. financial services industry — from the exchanges to the asset managers, investment banks and index providers." [12]
China's strategic use of capital markets: "I firmly believe that it is also official policy of the government of China to abuse the capital markets to facilitate the trade practices that are deleterious to the American economy." [12]
The unreliability of Chinese audits: Block argues that even if U.S. regulators could inspect Chinese audits, there's "no reason to believe that such inspections would be free of CCP [China Communist Party] manipulation and interference." [12]
The evolution of fraud in China: Block notes that while early Chinese frauds were less sophisticated, today's market involves more manipulation and market-savvy players. [13]
On the difficulty of proving online fraud: As Chinese companies have become more internet-based, it's harder to prove fraud to the satisfaction of U.S. investors. [13]
The geopolitical dimension of Chinese listings: Block suggests that China encourages its companies to list on U.S. exchanges to gain leverage over Western business and political leaders. [14]
On the UK market's vulnerability: "You have this much more clubby atmosphere than you do in the US...The personal relationships and the focus on pedigrees...I think that at times it does make UK investors more susceptible." [8]
Shifting focus to other emerging markets: Block has expressed a preference for long-term investments in countries like Vietnam, seeing them as beneficiaries of a potential shift away from China. [15]

On Investment Philosophy and Market Dynamics

The power of having nothing to lose: Reflecting on his first major short, Block said, "there's a power in feeling like you have nothing to lose." [16]
The importance of intellectual diversity: "Be intellectually diverse. Never stop learning." [17]
Learning from mistakes: "Aim for mistakes, learn how to manage risk." [17]
The distortion of passive investing: "So much of what moves stocks is really just flows into and out of index funds." [2] He believes this creates a "warped" market where fundamentals matter less. [11]
The danger of passive fund liquidation: In a downturn, passive funds will have to liquidate holdings at any price to meet redemptions, potentially causing a sharp and disorderly correction. [5]
Respecting momentum: "As somebody who's been a short seller for the past 15 years you have to respect momentum. You have to respect sentiment. I wouldn't stand in front of this train at this point in time." [14]
The problem with CEO incentives: Block argues that massive stock awards encourage short-term thinking at the expense of long-term company health. [1][18]
The folly of chasing hype: "Don't Chase The Hype Stories. Reality Catches Up." [19]
On SPACs: "Well, I mean, a lot of them are complete garbage. And the reason why you see so many shitcos going public via SPACs is they couldn't do it through IPOs." [19]
The impact of loose monetary policy: "Companies with access to extremely cheap money were just able to string out their demise." [20]

On Ethics and the Role of a Short-Seller

Short-sellers as a check on the system: Block sees activist short-sellers as stepping in where regulators cannot or will not act. [8]
The moral dimension of capital allocation: "You are there are companies out there that are not frauds...and are being starved of capital...because capital is being allocated to pieces of shit like this." [21]
On ESG investing: "It's the paper straw of investing...it's purely performative." [14]
The integrity of the research: Muddy Waters' ethical stance is predicated on the integrity of their research and the public disclosure of their short positions. [22]
On being demonized: "It's easy to demonize short sellers right as part of the populist message." [2]
The value of skepticism: Block's journey into short-selling was fueled by a deep-seated skepticism and cynicism born from early career experiences of being lied to by management. [16][21]
The goal is not just to be right, but to effect change: While profiting from a falling stock price is the goal, Block also expresses a desire for justice and for fraudulent actors to be held accountable. [18]
A necessary evil: Short-sellers contribute significantly to the health of the market, acting as watchdogs over listed companies. [22][23]
The personal philosophy: "Don't kid yourself about who you are." [17] Block's career path reflects an acceptance of his contrarian and skeptical nature.
The ultimate justification: "If capitalism breaks, it's capitalists who broke it." [4] This quote encapsulates his view that by exposing the system's flaws, he is ultimately working to preserve its integrity.

Learn more:

Lessons from Carson Block

On Short-Selling and Activism

On Fraud and Due Diligence

On China and International Markets

On Investment Philosophy and Market Dynamics

On Ethics and the Role of a Short-Seller

Written by Antoine Buteau

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