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.

SEC Saves Wealthy Chinese Investors from Losing $150 Million to Alleged Illinois Fraudster

The SEC today announced it had stopped an alleged scam committed by an Illinois resident who raised $145 million dollars plus $11 million in administration fees from hundreds of wealthy Chinese investors to invest in a hotel and conference center as part of an investor/immigrant pathway program to obtain U.S. citizenship.

While the $11 million in fees are likely unrecoverable, the SEC took swift action to freeze $145 million in cash, preserving nearly all of the duped Chinese investors’ assets.

Comment: Can China please now reciprocate and take similar legal action to freeze the assets of dozens of Chinese fraudsters such as Ming Zhao who deceived U.S. investors?

Sino Clean Energy Delisting is a Lesson for China Frauds

Beginning in April 2011 I wrote a series of reports exposing the massive fraud Sino Clean Energy (“SCEI”) conducted against its investors.   SCEI’s chairman and chief fraud orchestrator Baowen Ren fought back hard, fabricating shipping records and production videos and hiring Loeb & Loeb to try to clear his name by suing those who exposed the fraud.   SCEI then partnered with lawyers from Silvercorp Metals and Deer Consumer Products in a “war” against short sellers that allowed SCEI to perpetuate its fraud against investors for another year.

Knowing I was 100% right about SCEI I might have simply sat back and let my lawyers fight Ren’s frivolous defamation suit to victory, a victory that was assured after the New York Supreme Court in August dismissed Silvercorp’s frivolous lawsuit against me for violating my right to publicly express my opinion.  However, I found it far more effective to further document SCEI’s idle factories and blow the whistle to regulators.  The resulting trading halt and delisting came like a thief in the night to investors who, blindly trusting in SCEI’s defenders, ignored the overwhelming evidence of fraud. 

While the lesson for investors is clear, the lesson for China Frauds is disturbing.  SCEI would still be trading on NASDAQ today, continuing to defraud investors, if Baowen Ren had been wise enough to leave short sellers alone.  Ren was rash to retaliate against short sellers while his factories sat idle.   Ren overestimated the power of his legal team to convince regulators to ignore whistleblowers with an impeccable track record of exposing fraud.

In keeping with my commitment to only publish reports on exposing Chinese U.S. listed companies that continue to retaliate against critics via physical threats, violence, corruption of the Chinese police or abuse of the U.S. legal system, following SCEI’s delisting and withdrawal of its lawsuit against me, I will remove all reports on SCEI from  Munus explendum!

Court Victory for Free Speech Will Protect Investors

On 8/16/12 the New York Supreme Court’s Honorable Justice Carol R. Edmead dismissed Silvercorp Metals’ (NYSE: SVM) defamation lawsuit brought against numerous parties including myself.  Justice Edmead found that my blog posts on Silvercorp were an expression of my opinion of the company and protected by my First Amendment right of free speech (the full text of her ruling can be found here).  I applaud this decision that protects my rights and assures investors will continue to hear alternate viewpoints from bloggers who might otherwise be afraid to express negative opinions due to the threat of legal retaliation.

Over the past two and a half years I have publicly shared signs and evidence of fraud or questionable practices of over a dozen U.S. listed Chinese companies.  I publicly accused seven companies of defrauding their investors.  All seven have either been delisted or halted by the various stock exchanges where they traded.  The SEC charged three of the companies and/or their management with fraud.  My complete track record of all my reports can be found (here).

Three companies: Deer Consumer Products (NASDAQ: DEER), Sino Clean Energy (NASDAQ: SCEI) and Silvercorp Metals (NYSE: SVM) were the focus of’s continued mission (announced 12/19/11) to expose fraud, corruption, and other crimes by managements who utilize threats, false arrests, violent force, kidnappings, corruption of foreign officials and abuse of the legal system to silence their critics and deprive them of their right of free speech and expression of their investment opinions.  In addition to Justice Edmead’s dismissal of Silvercorp’s defamation lawsuit, I am very pleased to see that NASDAQ halted trading in DEER on 8/13/12 and announced its intent to delist SCEI on 8/7/12.

My efforts are now focused on Silvercorp.  I plan to publish a new report later this week.

Game Over for China Natural Gas: SEC Charges Company with Fraud

SEC filed a complaint yesterday alleging fraud against China Natural Gas and its Chairman Qinan Ji, (formerly NASDAQ: CHNG).  This marks the 3rd complaint in the past 3 months filed by the SEC against Chinese frauds first exposed by Jon Carnes, the owner of A*L.  On February 22nd, the SEC charged Ming Zhao, Chairman of Puda Coal, with fraud (link here).  On April 23rd, the SEC charged SinoTech Energy and its Chairman with fraud (link here).  The SEC’s press release and complaint against CHNG can be found here.

Mr. Carnes was the first to publicly accuse CHNG of fraud in an anonymous report published February 12, 2010 in an online blog.  An archive of the original report is available here.  Mr. Carnes removed the reports from the blog after being threatened by an agent of CHNG Chairman Qinan Ji.

In the SEC’s press release accompanying the complaint, John M. McCoy III, Associate Director of SEC’s Los Angeles Regional Office, stated:

“Ji betrayed China Natural Gas investors by misusing company funds to benefit his family and repeatedly lying about it.  Ji’s misconduct caused China Natural Gas to file a series of false reports with the SEC and showed total disregard for his obligations as an officer and director of a company whose stock trades in the U.S.”

The SEC’s complaint focuses on two events:

1)   Qinan Ji loaned over $14 million to friends and relatives without disclosing it and later lying to cover it up.

2)   Qinan Ji acquired Lingbao Yuxi for $19.6 million without board approval or properly disclosing the transaction.

Importantly, the SEC noted that its investigation of CHNG is continuing.

A*L commends the SEC’s actions and hopes the agency will continue pursuing fraudulent Chinese companies despite the inherent difficulty the SEC (and investors) face collecting settlements from Chinese entities.

A*L Scores Again: SEC Charges SinoTech Energy with Fraud

On February 22, 2012 the SEC charged Puda Coal’s chairman with fraud (link here), confirming each of the allegations in a report (link here) published on A*L on April 8, 2011. On August 16, 2011, A*L blew the whistle exposing the massive fraud at Sinotech Energy (CTESY.PK) in a report titled “SinoTech Energy: Enhanced Oil Recovery or Capital Extraction” (link here).  Unlike other numerous RTO frauds, Sinotech was a $120 million IPO listed on NASDAQ underwritten by UBS and Lazard Capital Markets that raised in total $168 million from investors and was audited by E&Y.

Proving that A*L was right once again, on April 23, 2012, the SEC charged Qinzeng Liu, SinoTech’s chairman and controlling shareholder, with securities law violations after he admitted to:

“… secretly siphoning at least $40 million from a SinoTech bank account in the summer of 2011. He then stood silently by as SinoTech – attempting to counter negative Internet reports that the company was potentially fraudulent – falsely assured investors that the company had that money and more in the bank.”

The complaint asserts that in SEC filings, SinoTech management:

“… represented that the company had purchased 16 LHD units worth $94 million. In fact, the company only acquired 11 such units worth less than $17 million.”

The SEC’s valuation of SinoTech’s LHD units affirmed our contributor’s conversation with Radial Drilling Services, a competitor, who estimated “an LHD unit should cost between only $300-700k depending on ‘bells and whistles’ installed, be it shallow or deep well units.”

According to the SEC, in order to hide the $77 million difference in the equipment cost, SinoTech tried to get its equipment supplier to make false statements supporting the inflated purchase prices.

Furthermore, the SEC stated that SinoTech “continued to materially misrepresent the value of its equipment – and by extension the company – in numerous filings and press releases following its November 2010 IPO.”  The SEC’s press release and link to the full complaint can be found (here).

The SEC’s complaint validates our report’s conclusion that SinoTech used an import agent to inflate LHD unit cost while funneling shareholders’ cash out of the public company.  Where did the $77 million SinoTech overpaid for LHD units go?

SinoTech was the 7th fraud exposed by A*L and proves again the valuable service that short sellers provide to the market (as explained by “Alfred Little” here).

A*L continues to fight to defend the First Amendment free speech rights of its contributors who bravely exposed fraud and corruption committed by more than a dozen Chinese U.S. listed companies.

The continuing mission of A*L is to bring Chinese companies that have threatened our contributors’ lives, free speech and privacy to justice.  As such, A*L and its contributors continue to offer their full assistance to the SEC and other regulators.  A*L currently only publishes reports on Chinese companies that continue to attempt, through threats, kidnappings, physical violence or abuse of legal process, to silence their critics.

Glenn Chan's Random Notes on Investing

DISCLAIMER: Some of the information on this site is wrong. Always do your own research.


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