The Block Inc (ASX: SQ2) share price is down around 15% after being on the receiving end of a short seller attack.
Short sellers are when investors are betting a share price will go down. Some short sellers publish negative research on a business to help the decline happen.
For readers that haven’t heard of Block, it’s the business that owns Square and Afterpay, making it one of the larger global payments businesses. It’s a bit smaller today though.
What happened?
As reported by media such as CNBC, the short seller Hindenburg Research revealed that Block was its latest short target.
The suggestion is that Block is allegedly allowing criminal activity to operate with “lax controls” and this “highly” inflates Block’s cash app’s transacting user base, which is one of its most important performance metrics.
CNBC also reported that Hindenburg described Block’s internal systems as a “‘Wild west’ approach to compliance.”
Hindenburg suggested that, after talking with former employees, there has been pressure from management that led to laws relating to anti-money laundering (AML) and know your customer (KYC) being ignored.
Hindenburg decided to try opening accounts in the names of Donald Trump and Elon Mush, then obtained a cash app card under the “obviously fake Donald Trump account”. But, the card in Trump’s name arrived “promptly”.
Hindenburg wrote:
Former employees estimated that 40%-75% of accounts they reviewed were fake, involved in fraud, or were additional accounts tied to a single individual.
In sum, we think Block has misled investors on key metrics, and embraced predatory offerings and compliance worst-practices in order to fuel growth and profit from facilitation of fraud against consumers and the government.
Hindenburg said it has been looking at Block for two years, speaking to multiple former employees, who said that internal concerns were “suppressed” and user concerns were “ignored”, even though “criminal activity and fraud ran rampant on its platform.”
It was reported that up to 35% of the cash app’s revenue is derived from interchange fees, according to Hindenburg, translating to close to $900 million of revenue, which the short seller should be capped by law – but it “avoids that regulatory cap imposed on large financial institutions by routing the revenue through a small bank.”
Block response
It’s early days, this could grind on for some time, but Block said in a statement:
We intend to work with the SEC and explore legal action against Hindenburg Research for the factually inaccurate and misleading report they shared about our Cash App business today.
Hindenburg is known for these types of attacks, which are designed solely to allow short sellers to profit from a declined stock price. We have reviewed the full report in the context of our own data and believe it’s designed to deceive and confuse investors.
We are a highly regulated public company with regular disclosures, and are confident in our products, reporting, compliance programs, and controls. We will not be distracted by typical short seller tactics.
Final thoughts on the Block share price
These are fairly serious allegations, so it’s unsurprising that the share price has sunk, and now Block may need to somehow prove that Hindenburg is wrong to get investors back on their side.
Time will how this plays out. Not every short seller attack leads to permanent damage – look at what has happened with WiseTech Global Ltd (ASX: WTC).
