Review of “How Constraining Are Limits to Arbitrage? Evidence from a Recent Financial Innovation”

by Alexander Ljungqvist[1] and Wenlan Qian[2], Working Paper 19834 of the National Bureau of Economic Research

In this NBER Working Paper, Alexander Ljungqvist and Wenlan Qian (“L&Q”) independently analyzed 332 reports published by 17 small activist short-sellers (who L&Q refer to as “shallow-pocketed arbitrageurs”) spanning from 2006 until 2011.  L&Q made the following observations:

  • Short sellers spend considerable money conducting their research while facing high lending fees, difficulty borrowing shares, and expensive put option premiums.
  • Despite these challenges, short sellers are quite successful in correcting the overpriced stocks: “On average, the prices of target companies in our sample fall by 21.9% over 3 months and by 56.8% over 12 months, net of market movements.”
  • Short sellers overcome their high costs by publishing very detailed reports revealing new negative information that, only if credible, results in investors selling their holdings causing large share price declines.
  • With considerable accuracy, the short sellers’ reports are usually proven to be true:  “For example, 35% of targets are subsequently delisted, 38% replace their auditors or see their auditors resign, and 23% restate earnings. In fact, in only 19% of cases do subsequent investigations by the SEC, the Department of Justice, or a stock exchange disprove the alleged facts contained in the reports.”
  • Only short sellers “…with a history of making claims that are subsequently confirmed are able to induce the longs to sell and thereby put pressure on a target’s share price.  And it is only credible reports that generate profits for the [shorts], net of shorting fees: without credibility, prices do not fall significantly.”
  • Reports “…that present new facts previously unknown to investors (e.g., resulting from on-the-ground detective work) result in longs selling and rapid price corrections whereas reports that merely reinterpret known data do not.”
  • The three largest publishers of reports analyzed by L&Q were Citron Research (106), Alfred Little (37), and Asensio & Co. (34).
  • Chinese companies accounted for 51.3% of the sample.  However, L&Q asserts that their findings were “qualitatively unchanged” if they remove the Chinese companies from their sample.
  • The three short sellers with the “largest immediate market impact” were Chimin Sang (-19.9% on 3 reports), Alfred Little (-19.2% on 7 reports), and Muddy Waters (-18.0% on 5 reports).
  • The three short sellers with the largest market impact measured over three months were Asensio & Co. (-58.9% on 4 reports), Absaroka Capital Management (-54.1% on 2 reports), and GeoInvesting (-39.8% on 8 reports).
  • Short sellers “…also face the risk of being sued by their targets.”  However, the “…very real risk of lawsuits will, to some extent, keep the [shorts] from making claims they cannot substantiate.”
  •  The “…mean cumulative abnormal return is -56.8% over the 12 months following the release of a report, with 80 of the 113 targets experiencing negative abnormal returns.  This suggests that the information the [shorts] release usually proves correct.”
  • L&Q independently analyzed each short seller’s track record to gauge the credibility of the reports.  L&Q’s calculated an 81% credibility rating for the entire group of short sellers and a 100% credibility rating for Alfred Little.

L&Q’s research “…illustrates why financial markets need short sellers to function well.”  Furthermore “…the short sellers in our sample are information producers who help correct mispricing and thereby help make markets more efficient. This is all the more remarkable given that many targets in our sample were held by highly sophisticated investors who apparently did not spot the overvaluation until it was too late.”

I strongly concur with L&Q’s findings and believe their detailed analysis proves the value of the reports published on  I welcome L&Q to update their analysis at some point to include 2012 and 2013 short seller reports, as well as to calculate the price declines of short seller targets over even longer periods of time (such as one or two years after publication).  This is imperative given that over longer periods of time the “market” more accurately gauges the merits of any valuation dispute.

It is in the best interests of investors that the exchanges and the SEC find ways to better engage small activist short sellers in their fight against securities fraud.   The current Dodd-Frank Whistleblower program has, to date, failed to substantively reward short seller whistleblowers.  The exchanges are less interested in protecting investors and more keen to protecting themselves from legal entanglements that may arise from delisting any given company as a result of short seller allegations.  Yet the short sellers, as L&Q have conclusively shown, are usually right.

Note: All quotations in this review are copyright 2014 by Alexander Ljungqvist and Wenlan Qian.  The public may purchase L&Q’s report online in .pdf format from ($5) for electronic delivery.  Journalists can obtain copies for free.

[1] Alexander Ljungqvist is the Ira Rennert Chair of Finance and Entrepreneurship at NY University Stern School of Business.

[2] Wenlan Qian is an assistant professor in the department of finance at the National University of Singapore Business School.

A*L Responds to BCSC Allegations

Yesterday, the British Columbia Securities Commission (BCSC) announced it would hold a hearing to determine whether I fraudulently made certain statements in my September 2011 reports questioning the resources and grades of the SGX mine owned by Silvercorp Metals (SVM).

The BCSC’s allegations are false and without merit.  I am taking legal action to both defend my reports and to hold accountable those public servants at the BCSC who have ignored my warnings about SVM.

I am preparing a point-by-point rebuttal of the BCSC’s allegations that I will file in due course.

I have used for 3 years to publish my investment insights, both long and short.  Directly as a result of my efforts, all 7 of the companies I accused of fraud were delisted by the U.S. exchanges.  The SEC charged 3 of the companies with fraud.  I have saved thousands of investors hundreds of millions, perhaps even billions of dollars from the hands of fraudulent Chinese companies.

Jon Carnes

FAB Universal Media Kiosks: A Fundamental Misunderstanding?

After an unnecessarily long delay, on 12/10/13 FAB Universal (FU) finally responded, in part, to the numerous issues raised by others and myself.  FAB admitted that one of their Chinese “VIE” subsidiaries sold $16.3 million in Chinese bonds without disclosing the issuance to the SEC and U.S. shareholders in violation of numerous Federal securities laws.

The illegal bond issuance was first exposed on 11/15/13.  On 11/19/13 FAB CEO Chris Spencer acknowledged receipt of an email from me that contained a copy of the bond prospectus, clearly showing that FAB’s VIE subsidiary was the issuer.   Even though Chris had evidence in hand that proved the bonds were issued, he nevertheless authorized a press release the following day containing a “vehement denial” of all the allegations.

Chris’s reckless behavior lured investors into buying millions of more shares of FAB before trading was finally halted two days later.

In today’s report, I challenge FAB’s response point by point, showing:

  1. FAB has failed to take the most basic step allowing investors to verify the existence of its media kiosks.
  2. FAB does indeed guarantee a minimum return on franchisees’ investments.
  3. FAB has failed to acknowledge its removal pirated content from its media kiosks.
  4. FAB’s cash confirmations are meaningless.
  5. FAB’s independent directors have yet to agree to meet with me to review the evidence.

Click Here to Download Today’s Complete Report

FAB Management Caught Red-Handed Covering Up Piracy

On Monday, November 18th, 2013, my investigators caught FAB’s Chinese management in the act as they attempted a full-scale cover-up of the pirated U.S. movies on FAB’s kiosks.  In today’s report, I present “before” and “after” videos of FAB’s Beijing kiosks documenting the removal of the pirated U.S. movies.  My investigators interviewed FAB’s kiosk operators and discovered that FAB was removing all of the pirated U.S. movies over anti-piracy concerns after FAB’s “copyright licenses had expired.”  What a convenient coincidence!

Click the image below to download today’s complete report:

Untitled 3

FAB Universal: “Best Buy Meets iTunes Meets Redbox” Meets FRAUD

FAB Universal Corp (NYSE: FU) claims to be a global leader in the distribution of copyright-protected digital media.  FAB derives substantially all of its revenue and profit from its Chinese subsidiary, which, according to its FY2012 10-K filed on 3/18/13:

“… is engaged in marketing and distributing various officially licensed digital entertainment products under the ‘FAB’ brand throughout the PRC…”

At the core of FAB’s Chinese business are its “Intelligent Media Kiosks” allowing consumers to download copyright-protected movies and music to their portable storage devices.  FAB claimed to have 3,954 such “intelligent” kiosks in Beijing alone, according to its 6/1/12 proxy (DEF 14A, filed with the SEC on 6/15/12), with over 16,820 active kiosks deployed in 40 Chinese cities according to FAB’s 11/13/13 press release announcing 2013 Q3 financial results.

In today’s report I will show that:

  1. Contrary to FAB’s anti-piracy claims, FAB’s “Intelligent Media Kiosks” are in reality loaded with very obviously pirated U.S. movies.
  2. FAB’s kiosk manufacturers acknowledged that: a.)   They historically supplied around 1,600-1,700 kiosks to FAB, only 10% of the 16,820 units FAB claims to have deployed. b.)  One kiosk supplier helped FAB stage phony manufacturer site visits for FAB’s investors, reminiscent of the China Integrated Energy (CBEH) fraud I exposed in 2011.
  3. FAB’s director of franchisee sales acknowledged that: a.)   FAB has only around 1000 kiosks in Beijing (compared to 3,954 disclosed in the 6/1/12 proxy); and b.)  FAB promises kiosk franchisees guaranteed minimum returns on their investments and offers to buy back the franchised kiosks using FAB U.S. listed common stock.

Based on the interviews and evidence that I collected, I conclude that FAB’s business in China is a tiny fraction of what it claims in its SEC filings.  FAB’s actual profitability would be reduced even further if the company upgraded its pirated content to properly licensed content (assuming that is even possible).  Finally, FAB has potentially enormous undisclosed liabilities for guaranteeing minimum investment returns to franchisees and undisclosed potential dilution from common stock issuable to franchisees.

Click Here to Download the Complete Report

A*L Prepares to Expose More Chinese U.S. Listed Frauds

I am now preparing to publish new reports exposing more Chinese U.S. listed stock frauds that I am certain will be delisted and decline to zero.  As I have done in the past, I am sharing all of my evidence with the appropriate regulators so they can take action against these companies and their management, some of who are U.S. citizens.

Click Here to View Today’s Complete Announcement


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