US Short-seller alleges accounting fraud by Fairfax

Indian-Canadian entrepreneur Prem Watsa‘s Fairfax Financial Holdings has faced a short seller attack from US hedge fund Muddy Waters, which alleged wrongdoing on the part of the Toronto Stock Exchange-listed company and sent its shares tumbling by 12% on Thursday.

The stock pared some of the losses on Friday after a research note from the National Bank of Canada downplayed the allegations.

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Muddy Waters alleged that Fairfax Financial Holdings inflated the fair value of its assets which resulted in notional profits that boosted the company’s book value.

Fair value is arrived at by benchmarking the value of an asset, in this case Fairfax’s investments in shares of companies, with its market value.

Book value, also known as total shareholders’ equity, comprises profits that a company makes as well as equity invested by shareholders. The profits made in a financial year are added to the book value at the beginning of the following accounting year. Increases in fair value of investments held by a company, which are effectively notional profits, also get added to its book value.

Muddy Waters accused Fairfax Financial Holdings of inflating its book value by $4.5 billion to meet its target of showing 15% compound annual growth rate in book value per share to its share owners. The company’s book value, as of December 2022 last year, was $15.3 billion, as per its annual report. Its book value per share was $658, a figure which is arrived at by dividing the book value by the number of shares outstanding. It had total assets of $84 billion.

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Short sellers make money by betting against a stock. Muddy Waters has a short position on the Fairfax Financial Holdings stock, as per a disclosure by it.