What's a "Muddy Waters"?

Hard to believe that $918 million of market value can get wiped away simply because a guy shouts “ponzi scheme” into a market bullhorn. Sell first, ask questions later seemed to be the response today to a “research report” by the previously unheard of Muddy Waters regarding TSX-listed Sino-Forest (TRE:TSX). Just because YBM or Bre-X came to pass, doesn’t mean that this is another example of lax oversight of an offshore play. For the TSX to halt the stock on a bear’s report, though, makes you wonder why they’re so skittish.

Here’s what’s being reported about the Muddy Waters call:

Muddy Waters is initiating coverage on Sino-Forest (OTC: SNOFF, TO:TRE) with a strong Sell rating.

According to Muddy Waters, like Madoff, TRE is one of the rare frauds that is committed by an established institution. In TRE’s case, its early start as an RTO fraud, luck, and deft navigation enabled it to grow into an institution whose “quality management” consistently delivered on earnings growth. “TRE, which was probably conceived as another short-lived Canadian-listed resources pump and dump, was aggressively committing fraud since its RTO in 1995. The foundation of TRE’s fraud is its convulted structure whereby it runs most of its revenues through “authorized intermediaries” (“AI”). AIs supposedly process TRE’s tax payments, which ensures that TRE leaves its auditors far less of a paper trail. On the other side of its books, TRE massively exaggerates its assets. We present smoking gun evidence that TRE overstated its Yunnan timber investments by approximately $900 million. TRE relies on Jakko Poyry to produce reports that give it legitimacy. TRE provides fraudulent data to Poyry, which produces reports that do nothing to ensure that TRE is legitimate.” TRE’s capital raising is a multi-billion dollar ponzi scheme, and accompanied by substantial theft.

I’ve known Sino CFO Dave Horsley for a long time, and the board is full of guys you will come across if you spend an extended period of time on Bay Street. If it’s an accounting scam, ala Madoff (as MW specifically claims), then a bunch of CAs on the board have been fooled as well.

It is so natural to assume that Muddy Waters (or their clients) were short Sino shares before the report was issued. Given the fun and satisfaction Biovail has had chasing down their short-sellers (ignoring how things wound up), there’s already a playbook that Sino can follow once this gets run to ground.

According to a Reuters story, there’s been a huge ramp in short interest at Sino in the past few weeks, despite positive news at the company:

Short selling totaled a record of 33 percent of Sino-Forest’s shares outstanding shares as of May 31, up from 18 percent at the end of April and 13 percent at the beginning of the year, according to Data Explorers, a New York-based research firm. Short sellers have borrowed 82 percent of the company’s lendable supply, meaning there is limited equity available for short sellers to bet against.

It’s almost as if they knew that Muddy Waters was about to issue the “research report”, and loaded up on their short positions in advance.

Investing in China via North American-listed public companies is fraught with assumptions and risk; but the YBM lesson surely taught Canadian directors to nail the facts down before they stepped into the board room. Certainly, that’s what TRE’s investors are hoping will turn out to be the case.

MRM