In a Case of Bad Ethics vs. Questionable Reporting, No One Wins

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Fellow Fool Rich Smith just last week looked at one of the worst acts of thievery that goes on in the marketplace -- insider trading. It's an everyday occurrence, and, worst of all, it's a perfectly legal and acceptable practice for members of Congress. If we can't trust our own government to set an example for Wall Street firms, how do we expect them not to follow suit?

On Monday, we witnessed yet another full-fledged attack on ethics violations, with research firm Muddy Waters, headed by its director of research Carson Block, bringing a strong sell recommendation and allegations of wrongdoing against Chinese media and advertising company Focus Media (Nasdaq: FMCN  ) .

Does this sound familiar? Well, it should, because Muddy Waters has been responsible for crying wolf on the accounting practices of Orient Paper (AMEX: ONP  ) , Spreadtrum Communications (Nasdaq: SPRD  ) , Sino-Forest, and RINO International, to name a few. Only two of the six companies Muddy Waters has issued strong sell recommendations on still trade on the national exchanges.

Now, I don't have a problem when a research firm comes out with a sell recommendation on a stock. In fact, I think we have far, far too many buy recommendations out there. What I do have a problem with are research firms that will blatantly front-run one of their own recommendations, knowing full well that their report is going to have an adverse impact on the stock price. Make no mistake: Carson Block and his research firm Muddy Waters admitted to having a short position ahead of today's news release. I still don't like it, though.

On the other side of the coin we have Focus Media, a company that, according to Muddy Waters research, overstated the number of LCD panels in its advertising network by as much as 50%. Focus Media is also purported to have deliberately overpaid for many of its acquisitions over the years, having written down $1.1 billion of the $1.6 billion in acquisitions it has made since 2005.

As much as I'd like to believe in the Focus Media story, Muddy Waters has had a knack for exposing egregious abuses of ethics in Chinese companies over the past year. Since these allegations were made, Focus Media has blasted back with a letter backing up the assertion that it has a network of approximately 178,000 LCDs and that its investments were crucial to getting its network to where it is today.

So what this really comes down to is a battle of bad ethics versus questionable reporting. Which do you trust: a company that front-runs its own reports but often appears correct, or the company being attacked that could just as easily wind up on the short end of the stick, as many of its fraud-alleged peers have?

Thus far, the Securities and Exchange Commission doesn't seem to care for either. Many of the companies Muddy Waters has come out against are currently under SEC investigation. Muddy Waters received notice of a formal investigation in June regarding possible stock-price manipulation of three companies it was covering at the time.

Honestly, in the case of bad ethics versus questionable reporting, no one wins and investors definitely lose. Chalk up another reason for the American public to distrust Wall Street.

What's your opinion of Muddy Waters or Focus Media? Share your thoughts in the comments section below, and consider adding Focus Media to your free and personalized watchlist to keep up on the latest news with the company as it develops.

Fool contributor Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy that's always looking out for your best interests.

Read/Post Comments (5) | Recommend This Article (8)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On November 23, 2011, at 11:22 PM, HarryCaraysGhost wrote:

    Hi UL,

    Muddy does serve a purpose by reporting on Chinese scam stocks.

    (one that I owned and was able to get out whole comes to mind, CCME)

    Your absolutly correct that no journalist should be able to trade shares while bashing a stock. It's just a conflict of interest, so why even go there unless for personal gain.

    I feel the same way that all politicions should have a passive account. If they want to be in the market.

    If a writer feels like going long on a stock the Fools disclosure policy should always be deployed.

    Muddy needs to clean that up, otherwise there will always be doubt.

    As for myself- set up in a DEF portfolio.No confidence in shaky Co's that might be manipulated.

    Happy Thanksgiving!

  • Report this Comment On November 24, 2011, at 9:39 AM, decbutt wrote:

    In a country that prides itself for "checks and balances" it is outrageous that a president can appoint the unelected Haliburton as VP, and then set about spending galactic sums of money on oil and the military. Everyone except the tax-payer got stinking-rich from an unbelievable conflict of interest that would be illegal in the rest of the western world.

    Charlie Munger was right about incentives.

    Conflicts of interest being perfectly legal: something else to be thankful for.

  • Report this Comment On November 24, 2011, at 11:33 AM, HarryCaraysGhost wrote:


    Just to be clear, I put the DEF in there as a football referance, has nothing to do with military stocks.

    TMF has a petition you can sign against politcal shenanaghans.

    Sorry I don't have the link handy.

    Happy Thanksgiving.

  • Report this Comment On November 24, 2011, at 11:39 AM, easyavenue wrote:

    Commerce without morality is one of the eight great blunders of the modern world. Gandhi.

    I think this kind of thing has been going on longer than written history. But because of relatively new disclosure and oversight rules we're hearing more and more about them. So this is good, right?

  • Report this Comment On November 29, 2011, at 7:52 PM, dahne wrote:

    I think the China bashing has gone too far. It's fine to point out true fraud but this should be treated differently than misunderstanding or cultural differences. I think many of the accused companies are really OK but their responses to the accusations are ignored or rejected. This is not good for international relations, and the US does not benefit by insulting the Chinese.

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