With an outstandingly aggressive strategy, activist fund Muddy Waters has gone from nearly non-existent in 2015 to being one of the most feared bear funds on the global market. Using a grey area between market analysis and stock-dealing, Carson Block has found an almost-legal way of bleeding companies dry.

Squeezing in between two markets

For many years, stock markets were separated between people whose job it was to analyze and understand market dynamics, on the one hand, and people who wished to invest, on the other. Of course, any investor is eager to secure his wager, and temptations were therefore great to manipulate markets in order to make the investment strategy come through. Hence the numerous market-rigging laws, designed to prevent investment companies from derailing markets at huge economic costs, for their own personal benefits. Founder Carson Block has found a hole in the fence between investors and analysts: is Muddy Waters a research company which also happens to invest? Or is it an investment company with heavy-handed communication? With a majority of investments being by nature discreet, Muddy Waters systematically spreads massive and negative communication just after securing its short positions, resulting in stock prices plummeting. Simple and effective.

China and Europe as top targets

Although a few short-selling strategies have been launched against US-based companies (such as the Bank of the Ozarks), Muddy Waters has a distinct preference for overseas targets. Like any other investor, Carson Block wishes to obtain maximum return on investment, while keeping the consequences caused by his aggressive strategies to a strict minimum. Hitting targets in foreign countries will considerably complicate any procedures which his targets very often throw back at him. The strategy hinges on two levels: using the seamless global market to harpoon targets far away, while seeking protection behind the red tape barricades provided by rigid legal jurisdictions. So far, European targets have been German Ströer, French Casino group, Swedish TeliaSonera. Muddy Waters knows that European and Chinese jurisdictions will have little or no help from Washington, should they choose to prosecute. In effect, legal ramifications are often cancelled, enabling the activist fund to walk-away scot-free. Legal expert Ewan Roy says: “In the event of a dispute, the international element compounds the already complicated, lengthy and costly process of contract dispute resolution […] Individual contracts, whether commercial or personal, increasingly contain an international element. The judgment in an international lawsuit could vary depending on which national law is applied. The realm of conflict of laws is working toward resolving the barriers to these decisions.”

The trust solvent

One of the main legal indicator of any legal defamation lawsuit is the truthfulness of the information transferred. If a victim falls to short-selling strategies, and it can be proven that the short-seller has lied, the suit is likely to be a winner. So, does Muddy Waters spread true or false information? The answer is: it doesn’t matter. The modern-day globalized stock market is more fluid than any other before it, but it still relies on trust. By shedding doubt on the trustworthiness of a company, Muddy Waters artificially sets off a stampede, causing the share price to drop sharply and mechanically – whether allegations are founded or not. AMF officials stated: “It appears Muddy Waters sought to create a panic to impact shares given that it settled a large part of its short positions just after the publication of the report”, in the wake of Muddy Waters’ latest attack. Attacks on Stöer were launched on German television and caused the share price to drop 25% in less than an hour, resulting in an immediate and massive ROI for Muddy Waters. It is perfectly possible that many of the stockholders who dump their positions (thus creating the stampede) don’t believe the information disclosed by the activist fund: regardless, the damage is done, and they must save whatever can be.

Blowbacks from State authorities

Realizing that Muddy waters is a threat to national companies, several European agencies have launched initiatives against the activist firm, so as to protect their flagships. German agency Federal Financial Supervisory Authority and French counterpart Financial Market Authority both launched legal proceedings to protect their national firms, respectively Ströer and Casino group, from what they consider to be a vulturous and profoundly unethical firm. “Inquiries have been opened, looking at both the stock price movements and the release of financial information. Procedures are under way and the AMF will not comment on either the content, nor the state of progress, of these matters” an AMF spokeswoman said. Here again, Muddy Waters uses a subtle technique to use investigations launched against it: due to different business cultures and philosophies between the European and the Anglo-Saxon world, the terms “safeguard procedure” (a term used in Europe when a State shields a company from a specifically identified danger) and “bankruptcy protection” (which clearly rings the bell for a dying company) are often conflated. Muddy waters is therefore able to use the shield of the target to damage its credibility furthermore.

Muddy Waters has succeeded in securing an almost perfect win-guaranteeing strategy. Purchase the short position, defame (rightly or wrongly), then sell – and walk away with little or no consequences. Market manipulation made (somewhat) legal. Until the authorities, under the pressure of public opinion, address the new business practice, that is.

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Isabelle Walker