New York—Innovation in the investment research industry takes many forms from new research technologies, such as using bots to mine the deep web, to new forms of delivery such as blogs or chat rooms.  We recently stumbled on a differentiated business model which has been developed in the wake of declining Wall Street coverage of small cap stocks.  No, we're not talking about paid-for research (which is booming, by the way) or exchanges such as NRE, IRN or Bright Meridian designed to intermediate the payment for research by companies covered (which are not booming).   The approach is the opposite of paid-for research: short the under-covered stock then write a negative research report.

Citron Research

We came across this approach with the launch of Citron Research, which says it is a source of "skeptical stock critiques."  Actually, Citron Research is a rebranded version of stocklemon.com which has been around since 2001.  The approach is straightforward:

1.   develop a negative thesis on a small cap or micro cap stock which has little or no analyst coverage,

2.   put on a short position,

3.   release a negative research report. 

After the stock goes down, cover your short position and find the next short idea.

Wait, is this legal? you ask.  How does this differ from the accusations Overstock and Biovail leveled against Gradient?  Good questions.  Citron's approach differs from the Overstock allegations in that its website discloses (somewhat) what it is doing.  The disclaimer on the home page states: "At any times [sic] the principals of Stocklemon.com might hold a position in any of the securities profiled on the site. Stocklemon.com will not report when a position is initiated or covered. Each investor must make that decision based on his/her judgment of the market."  A separate disclosure page indicates that those behind Citron usually have a position: "The principals of Citron Research most always hold a position in any of the securities profiled on the site.  Citron Research will not report when a position is initiated or covered. Each investor must make that decision based on his/her judgment of the market."  The disclosure leaves something to be desired, but may be enough to protect Citron.

Or, maybe not.  One of the unsavory aspects of Citron Research is its anonymity.  There are no people listed—no analysts, no management team, no address, no phone number, nada.  There is an ability to send messages via a form.  This is partly self-protection against hate mail and harassment, but it does not instill great confidence in the research.

Matter/Anti-Matter

So what is the quality of the research?  The reality is that there is some value in it.  Take Citron's work on Tuberoo.com, a pink sheet listed YouTube wannabe.  Tubearoo.com is being promoted by a "Featured Stock Report" on www.VisionInvestorReport.com which is little more than a brochure comparing Tubearoo.com to YouTube.  For its part, Citron points out the weak financials behind Tubearoo.com ($960.00 in first quarter revenues), a ridiculous valuation, and the absurdity of the YouTube comparison.  Citron also links the parent of Tubearoo.com (Innovision International) to a Philippines-based bucket shop that is blacklisted by the Australian regulatory authorities.

In this case, Citron is a good antidote to what appears to be an attempt to hype a questionable pink sheet stock.  Think of Citron as the reverse to paid-for research.  It has even figured out how to use the PR channel so important to paid-for research.  Earlier this week, Citron sent out a press release saying it filed a "formal letter of complaint with the SEC" regarding Home Solutions of America.  This letter (which is anonymous and unsigned) was sent to the regional director of the SEC's office in Fort Worth (location of Home Solutions.)

Conclusion

There is great demand for increased small cap coverage.  We are getting requests from multiple buy side clients for guidance on good sources of small cap research.  This partly reflects the impact of CCAs on the second and third-tier brokers.  The smaller brokers have been providing research coverage of small cap companies in their region, and now they are getting less commission flow, as more buy side firms use CCAs.   The result is greater demand for small cap coverage. 

At the same time, paid-for research is flourishing, and, from the buy side perspective, some of it is well-researched, such as Dutton & Associates.  On the other end of the spectrum you have schlock such as www.VisionInvestorReport.com.  Citron, despite its own credibility issues, serves a useful function to the extent it creates a check on the more egregious paid-for promotionism.

[Footnote: One of the firms that Citron goes after is Xinghua Finance, parent of Ford Equity Research, Glass Lewis, and Washington Analysis.  The analysis is over-the-top, casting departed CFO Shelly Singhal as "puppetmaster of Xinghua Media,"   but does claim that, among other things, Singhal was a director of Chell Group, whose chairman was arrested by Canadian authorities for boiler room activities.]