Short sellers are often the only sheriff on Wall Street, a crucial role in a rigged stock market – easy to forget after the furor over the “most shorted stocks.”
By Wolf Richter for WOLF STREET.
Luckin Coffee, a Starbucks imitator and one of many Chinese companies with no operations in the US that have their IPOs in the US and raise funds in the US, filed for Chapter 15 bankruptcy in New York today. The downfall of Luckin was triggered by short seller Carson Block of Muddy Waters that published detailed allegations on January 31, 2020, of massive fraud at the company, perpetrated at the highest levels.
By the time the Muddy Waters report came out, the company’s stock – well, American Depositary Receipt (ADR) – had skyrocketed from the IPO price of $17 a share in May 2019, to $50 a share in January 2020, giving the company a market capitalization (share price times shares outstanding) of $12.6 billion.
The short-seller’s report caused the shares to zigzag lower. On April 2, 2020, the company finally admitted that it had fabricated $310 million (RMB 2.2 billion) in revenues for 2019, nearly doubling its actual revenues. It said that “beginning in the second quarter of 2019, Mr. Jian Liu, the chief operating officer and a director of the Company, and several employees reporting to him, had engaged in certain misconduct, including fabricating certain transactions.”
The fraud, perpetrated in China, was designed to drive up the share price in the US, and it had worked, being instrumental for a nearly 200% gain of the shares in eight months.
On the day the company admitted the fake revenues, shares plunged another 82%. Over the next few days, shares dropped further. Then trading was halted. Eventually, the Nasdaq delisted the ADR.
The short sellers allegations, which had forced the company to admit at least part of its wrongdoing, finally woke up the SEC, whose role is to protect investors from this sort of thing, but it is asleep most of the time. As long as shares are rising, there is nothing to protect. It’s only after they collapse, that the SEC wakes up.
So the SEC began poking around and on December 16, 2020, announced that it had charged Luckin “with defrauding investors by materially misstating the company’s revenue, expenses, and net operating loss in an effort to falsely appear to achieve rapid growth and increased profitability and to meet the company’s earnings estimates.”
The details of the charges confirmed the short seller’s allegations. But without the short seller, there would have been no charges by the SEC. And the fraud would have continued and expanded. And Wall Street would have been onboard, gleefully making money on this thing.
In a prepackaged deal, the SEC also announced in the same breath that Luckin had agreed to settle the charges by paying a fine of $180 million.
Carson Block didn’t do the research on Luckin himself. Someone else had done the legwork and had put together a detailed 89-page report, and had sent the report to a number of well-known short sellers in the US. Block took his short positions and then released the report. The other short sellers that had received the report didn’t jump on it.
Block, in an interview last June, told the Wall Street Journal that it was the first time he’d published someone else’s research to support his short position.
“It wasn’t anything glorious we did here. We just felt confident that the report was directionally correct, so we decided we’d be a good platform for it,” he said. He also said that he’d known the author of the report for several years but declined to disclose the author’s identity.
So now Luckin has filed for Chapter 15 bankruptcy in New York. In China, Luckin’s stores would remain open, it said in the press release, and operations would continue as normal.
But US investors that had believed the Wall Street hype and the company’s statements before and after the IPO, and that had funded the company in the IPO, or bought the shares after the IPO, got screwed.
Credit Suisse, Morgan Stanley, Chinese investment bank CICC, and Haitong International were the joint bookrunners on the IPO of this fraudulent company. And Wall Street Analysts, including an analyst at bookrunner Morgan Stanley, touted the shares.
On June 11, 2019, a couple of weeks after the IPO, Barron’s came out touting the shares and citing three analysts that had initiated coverage of the ADR that day, all with prices targets way higher than the price at the time. One of those analysts was Lillian Lou of Morgan Stanley.
Can investors expect to be served up real analyses by Wall Street when Wall Street makes so much money in fees coming and going off those investors?
Nope. All they will get is fee-generating hype and lies.
And the SEC won’t protect investors either. If it steps in at all, it’ll be late and after the collapse.
In these kinds of cases, a short seller is the only sheriff left on Wall Street. Everyone hates them. They take huge risks and can easily get run over by an organized short squeeze. And they’re not paid by taxpayers; they’re paid from the gains of their short positions, unless they get crushed.
In the furor over the superbly engineered and historic short-squeeze of the “most shorted stocks,” including GameStop and AMC, when the social media crowd vilified the short sellers and made them their target, it’s easy to forget the essential role short sellers play in a rigged market.
This historic short squeeze, engineered by a bunch of deeply cynical small traders, exposed just how rigged the market has been. Read… The Stock Market Is Broken, Now for All to See
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