Having positions and covering them openly on a near-live basis is a tricky business.  At issue is not so much an insider trading question, but when financial transactions meet issues behind freedom of speech.  Spreadtrum Communications Inc. (NASDAQ: SPRD) is the center of today’s debate.  A short selling report has the stock down sharply today due to questions of its accounting.  Yes, another Chinese accounting question.

We have previously opined that perhaps the only true freedom of speech in China may be by CFOs and other corporate officers who are allowed to say and publish whatever they want when it comes to balance sheets and revenues.  We also admit that it is becoming more than difficult to trust anything Chinese when it comes to finances.  Imagine when Hong Kong and Chinese regulators claim that some NYSE-listed and NASDAQ-listed companies actually do not meet all of the listing criteria for local regulation standards.  The logic must be, “Why not send the shares to the dumb Americans?  They buy everything else from us without concern over quality control.”

Today came a note from Muddy Waters noting, “Muddy Waters, LLC has begun researching Spreadtrum, Communications Inc. (NASDAQ: SPRD), and we have taken a short position in it. (Please see our disclaimer below.) We have identified a number of issues in SPRD’s filings, and we believe that there is a high risk of material misstatement in the reported financials. Our concerns are gravest regarding 2010 and 2011 numbers.”  The company does give its disclaimer here.

For whatever it is worth, Jefferies initiated coverage on Spreadtrum with a Buy rating and a $19.25 target.

The group (Muddy Waters) sent a 7-page letter to the Spreadtrum’s Chairman.  Some may ask if it is legal or moral to be shorting stock, sending letters to management, and making it public domain.  Again, this is likely a freedom of speech issue and how it ties into financial transactions.  As long as nothing is knowingly wrong that is brought up and as long as the firm is open and truthful about their position, technically there are no formal violations.

In one way of thinking about this, it is almost reverse activism.  Activist investors like Bill Ackman and Carl Icahn have used the media to support their rationale.  Why can’t short sellers?

There is one issue to consider though.  A short seller is far from being Warren Buffett.  Still, let’s take this to an extreme.  What if Warren Buffett gave a letter to management or what if he issued data that could be accessed by the public in nearly real-time each time he bought new shares or even more shares in a public company?  His current positions have a 45-day lag and it can still influence buying and selling behavior in shares.

Other recent Muddy Waters targets have been Sino-Forest Corporation, Duoyuan Global Water Inc., China MediaExpress Holdings, and RINO International Corp.

Spreadtrum shares are down 5% at $12.26 on over 30 million shares, but shares were down as much as under $10.00 today.  The 52-week trading range is $7.60 to $24.20.

Keep in mind that the short interest has already skyrocketed due to its “China Syndrome.”  The short interest was 5,077,716 shares as of June 15 settlement date, up almost 80% from the 2,823,301 shares in the May 31 settlement date’s short interest.  Whether you chase buying dips or whether you chase short sellers, always remember the golden rule for all investors: “Understand what you are investing in!”

As a final reminder, whether you trade these from the long-side or short-side… If these stocks get halted until more data can be submitted it doesn’t matter if you are long or short in the sense that your capital will be tied up either way.

JON C. OGG

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