Carson Block of Muddy Waters Research has risen to fame for his skill in outing Chinese frauds, making Bloomberg’s list of the 50 most influential people in global finance. The former Jones Day Shanghai lawyer and adjunct professor at Chicago-Kent College of Law coauthored Doing Business in China for Dummies. He has outed some notorious frauds in China, including Rino International and Sinoforest. He has also apparently misfired on some allegations. Block accused Orient Paper of serious fraud, yet a blue chip independent investigation found no evidence to support his allegations.
Block appears to have now turned his attention to the Big Four. In a recent letter to the PCAOB, Block charges the Big Four with conspiring with their clients in China to commit fraud. Block writes:
Even the most reputable auditors in China seem to be in a race to the bottom. We believe that there are particularly egregious situations in which some Big Four partners in China offices have actually conspired with their clients to defraud investors. Further, it is a reasonable proposition that the conflict of interest inherent in the Chinese auditor’s business model also affects the quality of US company audits.
Block’s comments came in a letter supporting a PCAOB proposal to require the disclosure of the name of the responsible audit partner on the audits of U.S. public companies. The proposal is standard practice in much of the world, including China. It is highly controversial, since audit partners are not keen on seeing mobs of unhappy investors at their doorstep in the event of an audit failure.
Block’s allegations, if true, are outrageous and will shake the profession to its foundations. I am not sure what he means by the Chinese auditor’s business model affecting audit quality. I don’t see much difference in the Chinese auditing business model than that used everywhere else. It is a long held belief that the practice of the company paying the auditor for the audit undermines the independence of the auditor. No one has suggested any viable alternative to this model other than government-conducted or supervised audits.
I have supported the actions of Carson Block and his peers as necessary forces in market mediation. Although they are highly unpopular in much of the investment community, they serve an essential role much like the hyenas or coyotes that drag down the weak and the sick of the animal kingdom.
These allegations against the Big Four are deadly serious, and if proven, would undermine the effectiveness of the capital markets. I hope that the PCAOB has demanded that Block provide evidence for his allegations. Block needs to understand that if you want to play with the big boys on the Bloomberg Top 50 list, you better be able to back up what you say.