One of Wall Street’s most feared short sellers explains its new campaign against a $42 billion financial services giant—which it says is worth up to 65% less than advertised

The American financial services giant MSCI has long been a staple of investors’ portfolios. Many of the world’s largest money managers rely on MSCI’s equity, fixed income, and real estate indexes, as well as its analytics tools, and its ESG ratings, to operate each day. That favored position has made the company a powerhouse of late, with its stock surging more than 225% over the past five years.

But noted short-seller Spruce Point Capital Management aims to puncture MSCI’s halo, issuing a short report Wednesday that argues the company’s weak growth prospects, unsustainable valuation, and dubious accounting and financial reporting choices could lead its stock to plummet 55% to 65%.

Moreover, the short seller claimed that the ESG ratings leader MSCI would itself receive a failing ESG rating if it were to be evaluated, due to its governance issues that have an air of nepotism.

“We believe MSCI is a classic case of a struggling company failing to transform itself while engaging in value-destructive (and even worse nepotism-like) acquisitions and share repurchases with abusive financial reporting and accounting tactics to bolster earnings,” Spruce Point’s team wrote in its Wednesday report.

In an interview with Fortune, Spruce Point’s founder and chief investment officer, Ben Axler, explained that he saw multiple “classic red flags” at MSCI during his investigation of the company that indicate its stock shouldn’t be trading anywhere near the premium it enjoys today. From MSCI’s shift to focusing on adjusted earnings instead of margins in its financial reporting, to its questionable $950 million acquisition of the commercial real estate analytics company Real Capital Analytics, Axler argues that there is “evidence of misalignment with shareholders” and “governance issues” that could spell trouble for stock.

An MSCI representative told Fortune via email that the company "categorically refutes the claims" made in Spruce Point's Jan. 17 report. "This report is an intentional attempt by a short-seller to target our stakeholders with misleading, incomplete and false information that aims to distract from MSCI’s successes and opportunities," the representative said. "MSCI has a strong culture of compliance and ethics grounded in our code of conduct and our commitment to leading corporate governance practices, demonstrated through our robust financial controls and transparent financial reporting."

Axler clarified that Spruce Point is “definitely not alleging anything illegal,” and he thinks MSCI can still turn things around given time, even if the current valuation is way off base. “We hope they listen to some of our criticisms,” he said. “I think a lot of it boils down to: can they improve their governance, fix some of the things we've outlined, and be more transparent?”

Here’s a look at some of Axler’s main concerns when it comes to MSCI.

A lofty valuation and client retention issues

First and foremost, Axler and Spruce Point argue that MSCI is trading at an unsustainable and “extreme” valuation relative to its peers. The financial services giant’s enterprise value to revenue multiple, a common metric used by investors to measure the relative value of a stock, was around 17x on Tuesday before the short report. That’s substantially higher than its peers S&P Global, Nasdaq, and Morningstar, at roughly 11x, 10x, and 6x, respectively.

In addition to being expensive, MSCI is beginning to have issues with customer retention, Spruce Point noted. Axler explained, “there's a belief that [MSCI] has a high client retention rate. And it's a sticky product,” which had led to the stock boasting a high valuation, but he believes “that's not immutable.”  The client retention rate in MSCI’s core index business, which makes up 58% of revenue, has declined for the past four quarters, Spruce Point noted. On top of that, roughly 17% of that segment’s revenue comes from BlackRock, which Spruce Point says has “embraced self-indexing,” reducing the utility of MSCI’s products.

Spruce Point also conducted a survey of 60 MSCI clients and found that “a substantial percentage” reported more outreach from competitors in the last 12 months. Axler and his team argue that rising competition from Bloomberg, Qontigo (which is owned by Deutsche Börse), and others is beginning to impact client retention.

There are also signs that MSCI is using “punitive price increases” on existing customers to maintain revenue growth, Axler told Fortune. Without these increases, Spruce Point estimates that new recurring sales fell 40% in 2023.

Questionable acquisitions and whiffs of nepotism

Beyond waning client retention and increasing competition, Axler and his team believe that MSCI has opted for acquisitions that don’t always make sense in order to boost its earnings over the near term.

They argue that MSCI’s 2021 acquisition of the commercial real estate data and analytics provider Real Capital Analytics (RCA) for $950 million might not have been in the best interest of shareholders. MSCI purchased RCA for roughly 13 times its run-rate revenue and 48 times EBITDA, a lofty valuation. “We believe the acquisition was littered with challenges and shows MSCI’s propensity for aggressive revenue and cost accounting to inflate its financial performance,” Spruce Point’s short report reads.

The report then cites a “former executive close to the situation,” who it says called the acquisition “a dumpster fire” and claimed that MSCI did not do “enough due diligence.”

Beyond the RCA acquisition, multiple purchases and actions by management had a hint of nepotism, according to Spruce Point.

The short-seller noted that MSCI originally was called Morgan Stanley Capital International, and the company has close ties with the investment bank of the same name. “Surprise, surprise! We find that MSCI has recently engaged in a suspicious pattern of making acquisitions and alliances that benefit Morgan Stanley and MSCI alums,” the report reads. “We term this nepotism-like dealing and there are many recent examples.”

Spruce Point gave three specific examples for its claims. First, MSCI struck a deal with the digital asset financial services firm Menai Financial Group in 2022 to provide advice on undisclosed terms. But Menai was founded by Zoe Cruz, a former co-president at Morgan Stanley. Similarly, in 2023, MSCI paid 10 times sales for Burgiss, a data and analytics firm that focuses on private markets, where Jay McNamara, a former executive committee member at MSCI, was president. And finally, in December 2023, MSCI paid an undisclosed amount to acquire the wealth technology platform Fabric, whose co-founder was formerly Morgan Stanley’s chief risk officer.

Again, Axler and Spruce Point are not alleging anything illegal here, but they are calling into question MSCI’s management’s decisions when it comes to these acquisitions.

“The question has to be: Are they doing these deals because they're in the best interest for MSCI as a business or are they doing these deals because they benefit people in the sphere of Morgan Stanley and MSCI?” Axler told Fortune. “We're trying to point out with the report that we've seen a suspicious pattern recently of these deals and alliances ultimately involving people within the sphere of Morgan Stanley and MSCI.”

Accounting concerns—and an ESG ratings leader with an ‘F’ rating

Another concern Spruce Point put forward touches on accounting and reporting issues. First, the short-seller notes that MSCI has stopped providing margin guidance and instead “modified its language about its attractive cash generation profile, while now emphasizing Adjusted EPS.”

The short sellers’ report alleges that MSCI also “wants investors to ignore real cash costs associated with software development activities,” estimating that the firm’s true adjusted EPS was 28% lower than what was reported in 2021 and 13% lower than what was reported in 2022.

From “ignoring” restructuring costs to incorrectly capitalizing acquisition costs that were supposed to be expensed, Spruce Point details a string of accounting issues that, it says, should be addressed by MSCI and are a concern for shareholders.

Finally, MSCI’s ESG business is facing increasing competition, according to Spruce Point. The ESG ratings business has been a bright spot for MSCI since 2020, with run rate revenue rising from $138 million to $297 million. But Spruce Point believes that “the growth spurt is ending not only from ESG pushback, regulatory uncertainty, and ESG’s market underperformance, but also [due to] MSCI-specific issues that are resulting in client loss.”

“Their competitive advantage in the business, we think, is narrowing,” Axler told Fortune. “Because you've got Bloomberg beefing up solutions. You've got Moody's, you've got some of the exchanges in there, like NASDAQ, that are able to collect ESG data...So we think that business is slowing, and the multiples should be compressing.”

On top of that, if you were to rate MSCI on an environmental, social, governance scale, it might not do very well. As a financial services company, the environmental part of the ESG scale wouldn’t be much of an issue for MSCI. But Axler argued that the company’s governance issues are so serious that it would likely receive an ‘F’ ESG rating overall.

The list of issues at MSCI, according to Spruce Point, goes on and on. MSCI’s chief accounting officer, for example, resigned in August without being replaced. A director at MSCI was also involved with the software company SolarWinds, which was charged by the SEC with fraud at the end of October. And there is a serious lack of U.S. accounting experience among MSCI’s auditors. Axler also noted that MSCI has launched indices that could put the company’s “social” rating in question, including some that focus on Chinese or aerospace and defense equities.

“MSCI is an ESG ratings leader, but nobody's really rated them. I think we're trying to take an independent view. It’s not necessarily an unbiased one when we're short the stock, but I think, we're trying to question, does the company that rates others’ ESG factors stand up after a review?” Axler said. “And we find a lot of shortcomings. We think a lot of things could be improved.”

Update, Jan. 17, 2024: This story has been updated with a statement from MSCI.

This story was originally featured on Fortune.com