Herb Greenberg got the chance to sit down with Carson Block, Founder of research firm Muddy Waters today to talk about investing in Chinese stocks, especially RTO (reverse-merger) situations.
I think he brought up a term seldom heard in the financial media – Potemkin Factory – and went on to explain some very basic tenants of due diligence apparently ignored by many investors Who Should Know Better.
John Hempton of Bronte Capital talked about this last week in a post about China MediaExpress Holdings and efficient markets (or lack thereof).
Both Block and Hempton are quick to point out that many people who were long CCME and other Chinese RTO names that claimed to have done their “due diligence” took many a shortcut that ended up biting them firmly in the ass. For instance, as Block said (re: Potemkin factories), if you want to see if a firm is legit, you don’t go on a pre-announced visit with investor relations and/or senior executives. You show up un-announced, giving managers zero time to put on a show to make everything seem on the up-and-up.
This is not rocket science, and does not cost alot to undertake, in time and money, but I’m amazed at how many people are so quick to cut corners when investing in prima facie questionable trades where even novice investors would exercize more prudence than normal.
Is CCME (etc) a fraud? All signs point to yes. Does that mean investors who were “duped” (i.e. allowed themselves to be easily duped) deserve to be made whole, or anywhere close? Not in my book, and as far as I can tell, not in anyone else’s, either. Those who were long despite oodles of orange/red flags should consider their loss an educational expense, and keep the lessons learned in the front of their minds for the remainder of their investing/trading careers.