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Seeking an edge, short-sellers turn to behavioural analysis

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When Muddy Waters unveiled a short position on Noble Group last week, it didn't just scrutinise the commodity trader's accounts. It also hired a behavioural analysis firm run by former CIA staff to analyse how Noble's executives talked on a recent earnings call.

[SINGAPORE] When Muddy Waters unveiled a short position on Noble Group last week, it didn't just scrutinise the commodity trader's accounts. It also hired a behavioural analysis firm run by former CIA staff to analyse how Noble's executives talked on a recent earnings call.

This type of analysis is the latest unorthodox research method used by short-sellers and independent research firms to boost the impact of reports they issue that challenge companies' accounting methods.

QVerity, the company hired by Muddy Waters, says it analyses the way people communicate to assess if they are being deceptive. It looked at how Noble's management responded to questions and interacted with analysts on its conference call. "The value that clients, particularly investors, are finding is that through behavioural analysis one can identify potential problems that might not be readily identified through other means," QVerity's CEO Phil Houston, who had a 25-year stint at the CIA, told Reuters.

He says they have many clients in the investment industry ranging from small firms to large financial institutions, but declined to name any.

Many are sceptical about the value this kind of analysis brings though, opting instead to stick with traditional research methods. "Some will think this is interesting, but we are fundamental analysts and have our own methodology and framework for doing company research," said Carmen Lee, head of OCBC Investment Research. She added that they have never used behavioural analysis and have no plans to do so.

The past few years have seen a growing number of activist short-sellers, who publish research questioning a company's accounts whilst betting on its share price falling.

They claim they take their research a step further than analysts at banks and brokerages, which enables them to uncover accounting shenanigans.

They have often hired private investigators, forensic accountants and visited factories at unscheduled times to probe irregularities at companies they target.

Muddy Waters' attack on Noble is the first time any high profile short seller has publicly used behavioural analysis though. Its founder Carson Block said he became interested in it after similar research was done on him and he largely concurred with the assessment, without specifying what the assessment was. "There might be a reluctance among investors to accept behavioural analysis, similar to the hurdles psychotherapy had to overcome before gaining societal acceptance," Mr Block said.

Noble hit the spotlight in February when an unknown firm calling itself Iceberg Research published the first of three detailed reports on the company on a blog alleging the commodities trader used aggressive accounting methods.

Noble has rejected all of Iceberg's claims and started legal action against a former employee whom it alleged was behind the reports. It is holding its annual shareholders meeting in Singapore on Friday.

Muddy Waters said last week that it had a short position on Noble, saying the findings of QVerity - that Noble management showed signs of deceptive behaviour in the way they answered analyst questions - supported at least some of Iceberg's allegations.

Examples in QVerity's analysis included saying that the way Noble CEO Yusuf Alireza thanked an analyst for his question and referred to him by his first name was a form of "manipulation behaviour".

A spokeswoman for Noble referred Reuters to its recent statement that categorically rejected all of Muddy Waters allegations, including the "unfounded" one that it misled investors.

Soren Aandahl, head of research at another prominent short-seller Glaucus Research, said he had some qualms about following Muddy Waters in using this type of analysis. "I'm not sure any conclusions derived from such analysis could be credibly relied upon. I'm also not sure it is necessary," he said.

Still, he argues that Muddy Waters' tack shows it's short-sellers rather than traditional analysts who come up with the most innovative investment research methods. "It takes insurgents to push traditional investment paradigms forward," he said.

REUTERS