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Short seller Carson Block makes his living by spotting frauds.
He made his name shorting the Chinese company Sino-Forest, and he tries to shine a light on companies that are total fakes and those that are stretching the truth.
In a recent conversation with Business Insider, Block said that he was seeing less of the out-and-out frauds that led to a total collapse of a company but that a new trend worried him.
"There are fewer and fewer abject frauds from places like China," Block told Business Insider.
"There has been a shift in accounting, though — more and more companies are using financial engineering to make things on their balance sheets look very different than they are," Block said.
He mentioned, as we have before, that the gap between adjusted earnings and nonadjusted earnings is the largest it has ever been, and corporate buybacks are at their highest level ever as well.
This sort of "financial engineering," in Block's opinion, lets companies get away with more than they would otherwise. And while there is nothing inherently criminal about this, many firms are coming up to the edge.
"It's kind of like the financial crisis in the sense that these companies aren't doing anything technically illegal but they're coming right up to the line," Block told us. "It's hard to find people to prosecute because they're not getting quite high enough for it to be fraud."
Essentially, Block is saying that these companies may not be doing anything legally wrong but that the engineering is distorting their true value in the market.
Oli Scarff/Getty ImagesThe difference in adjusted and unadjusted earnings has been a source of debate for some time. On the one hand, companies say writing off one-time losses gives a better picture of the underlying business. On the other hand, critics argue that ignoring the negative parts of the business is simply cooking the books to look better for investors.
Block is clearly in the latter camp, and he said finding the companies that consistently stretch their earnings was a good starting point for a short investigation.
Additionally, practices like stock buybacks have hit record numbers, allowing companies to hit analyst expectations for earnings. Some analysts feel this is financial engineering, to use Block's term, while others feel it's a legitimate use of capital to reward shareholders.
So while massive frauds on the level of Sino-Forest may not be as prevalent as they were when Block started six years ago, he thinks the breadth of the truth stretching is increasing and becoming more of a worry.
"It might not be illegal, but it is a major problem, and we're seeing it happen more and more," Block said.
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