Monday, 14 July 2014

Got ’em, Gotham

Good article in The Economist about the Gowex fraud, some snippets:

Gowex’s dramatic collapse marks one of the biggest victories for a relatively new breed of company-accounts “detectives”: small, independent research-and-investment outfits that revel in unearthing alleged book-cooking. Having focused largely on China’s fraud-filled market until now, they are branching out.

Gotham’s approach is to short and shout: it takes a negative investment position, then noisily publicises its findings. It is cut from the same cloth as Muddy Waters, which is run by Carson Block, a former self-storage entrepreneur. His biggest scalp to date is Sino-Forest, which went bust in 2012 after Muddy Waters accused it of overstating its forest holdings in China. Another such outfit is Citron Research, whose leader, Andrew Left, prides himself on never having been successfully sued for defamation.

Gotham spent eight months studying Gowex, amassing far better information than investment-bank analysts, most of whom were still recommending the shares when it buckled. Gotham spotted that Gowex used a little-known auditor (a classic red flag: see the Bernard Madoff case), whose fees were unusually low, as if they were based on revenue far smaller than Gowex’s books stated. Often, the sleuths comb the books for ratios that are hard to manipulate. Gotham also noted, for instance, that Gowex’s revenue per employee was implausible compared with rivals’—while the revenue could be inflated, it was harder to fake the headcount.

..... market regulators often eye them [short sellers] with suspicion: Spain’s at first reacted to Gotham’s report by investigating its publisher, not Gowex. China has cracked down on shorts, even imprisoning the writer of one negative report.

.... perhaps two-thirds of cases involve improper revenue recognition. New global accounting rules announced in May seek to curb one common ruse, booking sales prematurely, for instance on long-term contracts. But sometimes the revenues are simply invented, often by getting a related party to pose as a customer. Sometimes very closely related: Gotham said in its report on Gowex that it had evidence the firm’s biggest customer “was really itself.”

In the Malaysian context, no case of short sellers "attacking" a company has happened, nor do I expect that in the near future, despite Malaysia having its fair share of accounting frauds. It would be interesting though if something like the above would happen, given the "shoot the messenger" mentality. How would the company, the regulators and the press react?

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