The Downside to Exposing Corporate Fraud

Short seller John Hempton published an interesting post yesterday about explaining what he does to his son:

I went through the mechanics of short-selling. I borrow a share from a broker. I sell it in the market. If the stock goes down I get to buy it back for less than I sold it. I repay the loan by returning the share and I keep the profit. I explained it does not work so well when the stock goes up.

Then I got to the nub of the issue: I am a short-seller of frauds and stock promotes. I look for people in the stock market who have fake accounts and who are stealing from gullible shareholders (also known as marks, dupes, fools, day traders or mutual fund managers). There is a torrent of money being ripped off (many billions of dollars for instance in the case of the Chinese frauds a surprising amount of which came from Fidelity). Through short-selling I stick up my sail on my little boat in the hurricane of theft and some of that loot drops into the cabin.

[snip]

He asked if I ever dobbed the scammers in to regulators and I said I did sometimes but it was mostly not a satisfactory experience. To be a good short-seller I only need to be right about 90 percent of the time. If most the companies I short-sell have fake accounts I will do fine. However if I dob them into regulators I need to be absolutely right in that it does not bode well to dob an honest person into the authorities. So mostly I keep my gob shut and express my opinion (and it is an opinion) in a bet in the financial market.

Moreover talking about which stocks you think are frauds is a dangerous thing. Regulators sometimes (even foolishly) have been known to investigate short-sellers for telling the truth. (Being  short Lehman Brothers and vocal about it was a good way of getting an SEC investigation for talking truth to power.) Also crooks sue short-sellers giving you nasty and expensive legal bills.

And then Jeff Matthews got right to the point about why exposing corporate fraud can be detrimental to the health of the investigator:

The real underlying issue is this: the downside of going public with damaging information on a public company, even if that information could bring down a bad guy and stop him from doing damage to other innocent investors down the road (e.g. Robert Maxwell, whose favored broker was Goldman Sachs, as described here), is somuch greater than keeping your mouth shut that it makes no sense (in America, at least) to bother.

What is that downside?  There are many facets, but the two main ones are these:

1) Getting sued by the offending scammer, who, being CEO of a public company, can spend unlimited company money on the effort, not his own;
2) Getting ignored (or worse–see David Einhorn’s experience in “Fooling Some of the People All of the Time“) by the Feds.

Now, what is the upside of going public?

Well, the upside is you may ultimately be proven right, and the bad guy may go to jail, in which case the investors and shareholders and analysts and investment bankers who hated your guts during the process and wanted to see you die because it was you (not the bad CEO) who was destroying their company, will finally admit you were right and shower you with kisses—no, wait.

They won’t.
They will still hate your guts.
In fact, they’ll hate your guts even more, because they will perceive that it was you who brought their company down.  After all, without your efforts the fraud they were profiting so handsomely from would not have collapsed.
They’ll think, in fact, that you’re evil.

So, to summarize: Upside to doing the right thing by going public? Zero.  Downside? Financial ruin.

I couldn’t have said it better myself.

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