In a Case of Bad Ethics vs. Questionable Reporting, No One Wins

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Fellow Fool Rich Smith just last week looked at one of the worst acts of thievery that goes on in the marketplace -- insider trading. It's an everyday occurrence, and, worst of all, it's a perfectly legal and acceptable practice for members of Congress. If we can't trust our own government to set an example for Wall Street firms, how do we expect them not to follow suit?

On Monday, we witnessed yet another full-fledged attack on ethics violations, with research firm Muddy Waters, headed by its director of research Carson Block, bringing a strong sell recommendation and allegations of wrongdoing against Chinese media and advertising company Focus Media (NAS: FMCN) .

Does this sound familiar? Well, it should, because Muddy Waters has been responsible for crying wolf on the accounting practices of Orient Paper (ASE: ONP) , Spreadtrum Communications (NAS: SPRD) , Sino-Forest, and RINO International, to name a few. Only two of the six companies Muddy Waters has issued strong sell recommendations on still trade on the national exchanges.

Now, I don't have a problem when a research firm comes out with a sell recommendation on a stock. In fact, I think we have far, far too many buy recommendations out there. What I do have a problem with are research firms that will blatantly front-run one of their own recommendations, knowing full well that their report is going to have an adverse impact on the stock price. Make no mistake: Carson Block and his research firm Muddy Waters admitted to having a short position ahead of today's news release. I still don't like it, though.

On the other side of the coin we have Focus Media, a company that, according to Muddy Waters research, overstated the number of LCD panels in its advertising network by as much as 50%. Focus Media is also purported to have deliberately overpaid for many of its acquisitions over the years, having written down $1.1 billion of the $1.6 billion in acquisitions it has made since 2005.

As much as I'd like to believe in the Focus Media story, Muddy Waters has had a knack for exposing egregious abuses of ethics in Chinese companies over the past year. Since these allegations were made, Focus Media has blasted back with a letter backing up the assertion that it has a network of approximately 178,000 LCDs and that its investments were crucial to getting its network to where it is today.

So what this really comes down to is a battle of bad ethics versus questionable reporting. Which do you trust: a company that front-runs its own reports but often appears correct, or the company being attacked that could just as easily wind up on the short end of the stick, as many of its fraud-alleged peers have?

Thus far, the Securities and Exchange Commission doesn't seem to care for either. Many of the companies Muddy Waters has come out against are currently under SEC investigation. Muddy Waters received notice of a formal investigation in June regarding possible stock-price manipulation of three companies it was covering at the time.

Honestly, in the case of bad ethics versus questionable reporting, no one wins and investors definitely lose. Chalk up another reason for the American public to distrust Wall Street.

What's your opinion of Muddy Waters or Focus Media? Share your thoughts in the comments section below, and consider adding Focus Media to your free and personalized watchlist to keep up on the latest news with the company as it develops.

At the time this article was published Fool contributorSean Williamshas no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen nameTMFUltraLong, track every pick he makes under the screen nameTrackUltraLong, and check him out on Twitter, where he goes by the handle@TMFUltraLong. Try any of our Foolish newsletter servicesfree for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has adisclosure policythat's always looking out for your best interests.

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