Gotham City Research, a private company that bets against the companies they find to be fraudulent, announced their most recent target this past summer: Let’s Gowex SA, a Spanish Wi-Fi provider. Within days, Gowex collapsed entirely and trading has been suspended, making their shares essentially worthless.
Gotham City Research, along with a Chinese firm called Muddy Waters Research, is a new kind of corporate watchdog, one that stands to make a profit off the crime it discovers. Profit will thus act as an incentive to expose wrongdoing, and although this business scheme may be abused by less reputable companies, it will make it much more difficult for companies to evade justice.
Gotham City Research (GCR) does not bust other companies to make the world a better place. When GCR discovers evidence of fraud by analyzing another company’s financial documents, it borrows shares of their target from an investment bank. Immediately afterward, they sell the documents in a process called short selling. Then GCR publishes their fraud report on the Internet.
Other investors begin to sell shares of the potentially fraudulent company, out of fear of government intervention and because they know now that their investment is worth less than they initially believed. This sudden surge in sales causes share prices to drop, because there are now more sellers than buyers.
Now, GCR purchases these shares for close to nothing and returns them to the bank they borrowed from. This difference between the price they sold the stock for and what it was bought it for is their profit. Which means if the company goes bankrupt, GCR has doubled its money.
The potentially enormous profit creates an incentive to lie. An investment group may invent misleading information about a company to make money off the downside, called a pump and dump scheme, which is illegal. Although normally done with positive information to increase the price of a share, shorting a stock can be just as profitable.
However, it is unlikely that a company will succeed in artificially deflating a stock’s value. By posting online that another company is committing fraud, it does not mean that investors automatically believe it.
GCR has gained trust from five accurate reports, and all stocks have dropped by 20 percent or more. Moreover, they use almost entirely public information in their analysis, many of their conclusions plainly obvious to anyone willing to do the research. For example, Gowex’s letter to English-speaking investors contained factual errors conspicuously absent from the Spanish version.
GCR presents more than just a novel way for a company to turn a profit: It has the potential to fundamentally change the way corporate responsibility is handled.
Currently, the only groups investigating fraud in the business world are government organizations like the SEC, investigative journalists and, to a much lesser extent, corporate overseer groups like FINRA. These groups are understaffed and ill-equipped to investigate every single company, enabling criminals to keep fraud undiscovered for much longer. Gowex, for instance, had been releasing fraudulent information for eight years before the truth was revealed.
When investigating wrongdoing becomes as profitable as committing it, it will become much harder for corporations to hide the truth from the outside world.
Andrew Langen is a sophomore majoring in economics and mathematics.