(Bloomberg) — From the savings and loan crisis in the late 1980s to Bernie Madoff’s reckoning in 2008, history is littered with financial misdeeds that only came to light after bouts of market turmoil.
Carson Block and other fraud hunters now say the next big wave of scandals may be imminent as the coronavirus crisis makes bad behavior tougher to conceal.
“When funding markets tighten, that stress always exposes frauds,” Block, the Muddy Waters Capital founder who’s best known for betting against companies with questionable accounting, said in an email interview. “I expect that there will be a number of frauds exposed as the 11-year bull market tide ebbs.”
Recent allegations of financial impropriety from Asia have already rattled investors.
In Singapore, the turmoil surrounding Lim Oon Kuin’s Hin Leong Trading (Pte) Ltd. intensified over the weekend after Bloomberg reported that Lim’s son said the embattled energy trader hid about $800 million in losses on futures contracts. The news followed a historic collapse in oil prices, which touched fresh 21-year lows in New York on Monday because of the supply-demand mismatch that’s been created by the coronavirus. Neither Lim nor his son could be reached for comment Sunday.
Read more: Singapore Oil Trader Is Said to Have Hidden $800 Million Losses
Earlier this month in China, Luckin Coffee Inc. shocked shareholders by saying its chief operating officer and some underlings may have fabricated transactions worth billions of yuan. The revelation upended one of China’s best growth stories, triggering an 81% drop in Luckin’s stock and sparking declines in other Chinese companies whose accounting has been questioned by short sellers.
Less than a week later TAL Education Group, a tutoring business whose founder is one of China’s richest people, said an internal audit found an employee had inflated sales by forging contracts. (Both TAL and Luckin were short-selling targets of Block’s firm.)
While recent accounting scandals may have come to light for different reasons, in general frauds often unravel during periods of financial-market stress, said Gillem Tulloch, whose GMT Research Ltd. is best known for flagging suspicious accounting at Chinese companies listed in Hong Kong.
The MSCI All-Country World Index of global shares is down nearly 20% from its pre-pandemic highs, even after rebounding from the depths of a historic crash in March. Credit markets also remain jittery despite stimulus-fueled gains over the past few weeks.
Tulloch said the incentive for corporate wrongdoing is greatest in highly leveraged parts of the economy going through difficult times, such as the commodity and property industries. He said investors should be wary of companies that appear hugely profitable but don’t pay dividends; generate free cash inflows but raise external capital; or have large amounts of debt but equally large amounts of cash.
With funding now harder to come by, firms that have been fudging their numbers won’t be able to rely on the capital markets to prop up their businesses, said Soren Aandahl, the founder of short seller Blue Orca Capital LLC. “Across the market, there is a sentiment that after years of rising valuations and easy credit, we will now see which companies have been swimming naked.”
(Updates with market moves from fifth paragraph)
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