Whistleblower, or Opportunist? A Short Seller Helps the Government

FOIAengine Reveals the Litigious Path to a Big SEC Payout

Carson Block is a buccaneering stock trader, reveling in a role that’s long on risk and short on sympathy.  He’s an activist short seller, the most reviled guy in any room full of corporate executives.   

Block popularized activist short selling, targeting companies whose stock he believes to be drastically overvalued, then leading a short-selling frenzy that punishes the stock and enriches Block and his many followers, including 234,000 on Twitter.  Through his company, Muddy Waters Research, Austin, Texas-based Block was an activist short-selling pioneer long before higher-profile players, like Nathan Anderson’s Hindenburg Research, came along. 

Block burnishes his brand as a gladiator against the titans of law, government and business.  On Twitter, he calls himself a “skeptic, First Amendment advocate, [and] foot soldier in the Global War to Defend Truth.”  On the Muddy Waters website, he says he’s “doing the work Wall Street won’t.  Muddy Waters peels back the layers, often built up by seemingly respected but sycophantic law firms, auditors, and venal managements.”

Short selling is a legal trading strategy.  And although corporate issuers and meme-stock buyers may vilify them, a claim can be made that the activists actually make the stock market more efficient through their disclosures. 

Short selling works this way:  The short seller identifies a possibly overvalued target, borrows shares in that company, and then sells them at the current market price.  Later on, the short seller “covers the short” by buying back the stock at a hoped-for lower price, pocketing the difference.  The goal is to profit from the future decline in the stock price.  Activist short sellers take that one step further, typically publishing a research report that makes their case against the company, and then widely disseminating it across online platforms like Twitter in the hope that others will join the selling and drive the stock price down even more.  

The best-known short sellers have cult followings on social media and websites devoted to ranking their successes – and, sometimes, their noteworthy failures.  They’re reviled by the companies they target and the shareholders who suffer losses.

Muddy Waters’ website lists well over a hundred “research reports” since 2010 in which Block calls out corporate misconduct, with flair and attitude.  His reports have titles like “Irrefutable Evidence of Fraud” and “Turds in the Punchbowl.”   And Block gets the job done: stocks that he targets get punished, and his firm has thrived.   Muddy Waters’ latest filing with the Securities and Exchange Commission lists $346 million in assets under management, the majority for clients overseas. 

Block founded Muddy Waters while he was living in China and working as an attorney.  He’s proficient in Mandarin and authored the 2007 Wiley book Doing Business in China for Dummies.  Wise to the intricacies of the Chinese markets, he saw an opportunity to profit from attacking companies – initially, most were China-based – that he believed were overstating earnings or otherwise misleading investors.  Early on, in late 2011, Muddy Waters dropped a brutal research report on a Chinese company called Focus Media Holding Ltd.  Block accused Focus and its key executives of outright fraud.  He shorted the stock and exhorted shareholders to sell. 

Block got results:  The SEC started an investigation.  Focus Media imploded.  The company and its founder eventually agreed to pay $55.6 million in fines, without admitting wrongdoing.      

But behind the scenes, an even more compelling drama was slowly unfolding.  More than a decade later, the full tale now is visible, in sharp focus because of multiple lawsuits, FBI subpoenas, a newly unsealed Third Circuit opinion, and an innocuous-seeming request buried in FOIAengine over a year ago that signaled another lawsuit to come. 

The totality of these events demonstrate the risks and rewards faced by activist short sellers like Block.  They also illustrate the federal government’s seeming ambivalence about whether to treat the activists as “pump and dump” villains, or whistle-blowing heroes.   

Prosecutors from the U.S. Attorney’s office in Los Angeles served a search warrant in late 2021 on Block and other activist short sellers, seeking evidence of market manipulation.  Unlike a subpoena, which can be a routine request for information, a search warrant marks a higher level of seriousness since it can involve the seizure of documents and equipment. 

The SEC, meanwhile, secretly awarded Block $14 million for revealing the Focus Media fraud – despite the objections of its own staff in the whistleblower office.  The SEC staff based its objection on the fact that they already knew about the wrongdoing, because of Block’s wide dissemination of his report.  Three judges on the Third Circuit seemed to agree with the agency’s staff, writing in their just-unsealed opinion that “the SEC’s proffered justification” for awarding the money to Block over the staff’s objection “leaves something to be desired.”  Still, the reward, which was only revealed because of another lawsuit, makes Block one of the Dodd-Frank Act’s earliest successful whistleblowers – a true hero, at least to the SEC. 

The SEC’s whistleblower program has paid out at least $1.6 billion since it was created by Dodd-Frank in 2010, including a record payment last month of $279 million to one tipster.  Still, rewards are relatively rare.  The agency averaged about 30 awards per year in the first 11 years of the program; last year alone, it received 12,300 whistleblower tips. 

As Block’s situation illustrates, the agency can take years to make a decision.  The whistleblower program operates, by law, in near-total secrecy, and whistleblowers are guaranteed anonymity.  That is why Block’s involvement with the SEC apparently was unrevealed and unknown for more than a decade. 

Block’s identity was unmasked by a former associate, Kevin R. Barnes, who sued Block in August 2022 in the Southern District of New York for half of the reward – a claim the SEC already rejected on procedural grounds. (Barnes didn’t fill out the official SEC form, known as a “Form TCR,” which stands for “Tip, Complaint, or Referral.”  Block complied with all instructions.) 

It is unclear whether Block has yet received the $14 million reward for his efforts nearly 12 years ago. 

Block, in a 21-page defamation suit against Barnes filed last August in federal court in Austin, said he “has not received any of this award to date,” and accused Barnes of telling “the bald-faced lies that Block received the award, and [that] Block has refused to pay him from the proceeds.”  Block accused Barnes of tipping off a hedge fund in advance about Muddy Waters’ plan to publish about Focus Media, and then going to work “full time for the hedge fund that he tipped off.”  The lawsuit didn’t name the hedge fund. 

Block’s suit also alleged that Barnes’ nickname at Muddy Waters, during the short time Barnes worked there, was “Ripley, from The Talented Mr. Ripley, a film about a brazen imposter and con artist.”  You can see where this is going.  Both sides have dug in. 

Amid all this, Block filed suit last December against the agency that rewarded him, seeking documents from the SEC under the Freedom of Information Act.  That grabbed our attention for several reasons, not least because we are always interested in FOIA requests coming from short sellers.  In this case, Block’s identity as the requester wasn’t revealed until he filed his lawsuit, because the SEC originally named only Block’s lawyer as the requester.

FOIA requests to the federal government can be an important early warning of bad publicity, litigation to come, or major share-price moves.  That is why PoliScio Analytics’ competitive-intelligence database FOIAengine tracks FOIA requests in as close to real-time as their availability allows.  Of particular interest are requests that may significantly affect stocks and markets once the stories hit. 

What is interesting about Block’s FOIA request, and his subsequent lawsuit, are the names he is going after.  His targets aren’t the high-ticket stocks that are the typical fare of short sellers.  Rather, Block is fishing to find out from the SEC whether anyone from that agency has been in touch since 2018 with three specific individuals – Marc Cohodes, Joshua Mitts, and Marlon Paz – or with anyone from the Morrison & Foerster law firm. 

Block’s FOIA lawsuit is pending in the Western District of Texas.  We’ve reached out to all the parties.  More next week. 

Next:  Whistleblowers, Part 2. 

John A. Jenkins, co-creator of FOIAengine, is a Washington journalist and publisher whose work has appeared in The New York Times Magazine, GQ, and elsewhere.  He is a four-time recipient of the American Bar Association’s Gavel Award Certificate of Merit for his legal reporting and analysis.  His most recent book is The Partisan: The Life of William Rehnquist.  Jenkins founded Law Street Media in 2013.  Prior to that, he was President of CQ Press, the textbook and reference publishing enterprise of Congressional Quarterly.  FOIAengine is a product of PoliScio Analytics (PoliScio.com), a new venture specializing in U.S. political and governmental research, co-founded by Jenkins and Washington lawyer Randy Miller.  Learn more about FOIAengine here.  To review FOIA requests mentioned in this article, subscribe to FOIAengine.