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Short Seller Muddy Waters Behind Aluminum Report -- WSJ

10 Feb 2018 7:32 am
By Scott Patterson 

This article is being republished as part of our daily reproduction of WSJ.com articles that also appeared in the U.S. print edition of The Wall Street Journal (February 10, 2018).

Muddy Waters LLC, one of the world's most renowned short sellers, wrote an anonymous 2015 report that first drew attention to suspicious activity behind an enormous aluminum cache in the Mexican desert -- a stockpile that helped spawn federal investigations and highlighted aluminum trade imbalances with China.

The report's author had been a secret until Thursday, when Muddy Waters founder Carson Block said in an interview that his firm was behind the report. He said Muddy Waters planned to reveal its authorship in a court filing -- in response to a lawsuit from a California company it had targeted in the same report.

The San Francisco-based short seller first gained fame in 2011 following its revelations about fraudulent practices at Chinese forestry company Sino-Forest Corp., which later filed for bankruptcy. Mr. Block has a reputation for investigating Chinese companies, including most recently a Hong Kong-listed furniture maker and a dairy-farm operator.

Short sellers, which profit by betting on a company's share price falling, often work to highlight weaknesses in the company's balance sheet or, at times, nefarious behavior.

Muddy Waters' investigation -- which resulted in the anonymous report -- shows the extreme lengths some short sellers go to search out information on public companies and shape a narrative about them for the market.

Mr. Block said Muddy Waters used an alias, Dupre Analytics, to allege in a July 2015 report that the founder of Chinese aluminum producer China Zhongwang Holdings Ltd., Liu Zhongtian, was committing fraud. The report claimed Mr. Liu used billions in loans from Chinese banks to secretly purchase his company's aluminum and ship it overseas to facilities he controlled to make the company appear more profitable than it actually was.

The report claimed Mr. Liu and his family were involved in "the largest and most complex China fraud ever uncovered."

Mr. Block said he sent investigators around the world to gather evidence to produce the report. His firm wrote the Dupre report in a disorganized way to ensure no one would associate it with Muddy Waters' style, Mr. Block said.

After the report was released, trading in China Zhongwang's shares was halted for about two weeks in Hong Kong.

Mr. Block said his firm made a only "very small profit" from trades around China Zhongwang -- which he is no longer shorting -- but considered it "the best work we've ever done."

China Zhongwang didn't immediately respond to a request for comment. The company has always denied any connection to aluminum stockpiles in Mexico, Vietnam and elsewhere and has called the Dupre report "incorrect." The company's shares recovered and are now more than 20% higher than when Mr. Block's report emerged.

The U.S. levied large tariffs on China Zhongwang in 2009 in response to allegations that it was dumping cheap aluminum on the American market. The company has never responded to those accusations.

In November, China Zhongwang said Mr. Liu had resigned from his position as chairman, citing health reasons.

The Journal, in a series of articles beginning in September 2016, reported on alleged links between China Zhongwang and one of the world's largest aluminum stockpiles in Mexico, massive amounts of which were secretly moved around the world, according to company records, interviews, trade documents and legal filings. The sheer amount of metal helped depress global aluminum prices and is one reason for calls in the U.S. to slap new trade restrictions on Chinese aluminum.

Mr. Liu has denied any connection to the aluminum shipments. "These things have nothing to do with me," he said in a 2016 interview with the Journal.

Mr. Block said Muddy Waters would officially reveal its identity in response to a California civil lawsuit in San Bernardino Superior Court filed by Perfectus Aluminum Inc., which the Dupre report mentioned at length.

Perfectus, based in Fontana, Calif., said Dupre's report damaged Perfectus by making what it said were false allegations of fraud that were ultimately circulated in the wider mass media. Perfectus is asking for unspecified compensatory and punitive damages.

Mr. Block, in response to the allegations, said he stood by Dupre's findings.

Perfectus was once owned and operated by Mr. Liu's son, according to corporate-registration documents reviewed by the Journal, but it has denied any connections to China Zhongwang or Mr. Liu.

About a year ago, U.S. customs officials seized $25 million worth of aluminum owned by Perfectus at a California port, the Journal reported. In September, the Justice Department alleged in a civil complaint that Perfectus evaded $1.5 billion in tariffs by conducting an illegal scheme to smuggle banned aluminum into the U.S.

Perfectus declined to comment on Thursday. The company has denied evading tariffs. It has sued the U.S. government and is seeking the return of the material.

Mr. Block said he decided to publish the report on China Zhongwang anonymously because of safety concerns. It was a tough decision, he said, since it deprived his firm of credit for the report and likely diminished its impact.

Mr. Block said he first learned about China Zhongwang from another hedge fund investigating the company. A Muddy Waters researcher was familiar with China Zhongwang and agreed that it would be a good company to investigate, Mr. Block said.

Mr. Block was shown a photograph of a giant field of aluminum encircling a factory in a desert in Mexico. The facility was run by a company called Aluminicaste Fundición de México, which Mr. Block's investigators later concluded was at one time owned by Mr. Liu's son. Aluminicaste has denied any connection to Mr. Liu or his son. Attempts to reach Mr. Liu's son were unsuccessful.

Mr. Block said he in 2015 dispatched investigators to China, who started to track shipping containers full of China Zhongwang aluminum. After they discovered that some containers were going to a port in Vietnam, they sent investigators to the port. From there, they tracked the shipments to a company partly owned by Jacky Cheung, a business associate of Mr. Liu's who later became CEO of Perfectus. Attempts to reach Mr. Cheung were unsuccessful.

By the summer of 2015, Mr. Block said, he decided he had enough information to reveal his findings about China Zhongwang.

Write to Scott Patterson at scott.patterson@wsj.com

(END) Dow Jones Newswires

February 10, 2018 02:32 ET (07:32 GMT)

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