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Jim Chanos: Ackman, Einhorn Deserve Applause for Exposing Fraud

Herbalife (HLF) was again in the spotlight Tuesday when its accounting firm KPMG announced it has resigned as auditor of the nutritional product company amid an FBI investigation into insider trading.

This time, the investigation involves a former KPMG senior partner accused of leaking company information. Herbalife has said KPMG’s resignation had nothing to do with the company’s accounting practices or the integrity of its management.

Related: Herbalife Short-Seller Sues Banks, Ichan Over Alleged Fraud

The jury’s still out on the reality of Herbalife’s business model. Hedge fund manager Bill Ackman has called Herbalife an illegal pyramid scheme and has faced off against fellow billionaire and activist investor Carl Icahn.

Related: Why Bill Ackman Is Targeting Herbalife

The Daily Ticker sat down with hedge fund manager Jim Chanos, founder and president of Kynikos Associates, to talk about the role of hedge funds in exposing fraud. Chanos famously raised red flags over Enron’s fraudulent practices early on.

Related: Jim Chanos: Stay Away From U.S. Tech Firms

“I think [hedge funds] play an important part, particularly from the short side,” Chanos says from the sidelines of the Wine Country Conference in Sonoma benefiting the ALS Les Turner Foundation. “Short-sellers and hedge funds are actually real-time financial detectives in that they are incentivized through profit to ferret out fraud, and I think that’s a very important role that people forget about from time to time.”

At the same time, investors are also incentivized to talk their books to create opportunities that would benefit their positions. So what does Chanos think about what Bill Ackman has done in targeting Herbalife? (Disclosure – Chanos’ fund was short Herbalife a year ago but no longer has a position in the company).

Chanos applauds people like Ackman “that actually had the courage of their convicitions to go talk about and point out some of the inconsistencies they see in the financial statements.”

Chanos argues there are asymmetries in the industry where short-sellers are held to higher standards that other investors.

“People have no problem with people getting on the media and talking about their longs until the cows come home,” he says. “And yet when someone comes out with a case against a publicly-traded company – oh boy – bring the guillotine out. It’s why most people don’t do it.”

As for accusations of Herbalife being a fraud or pyramid-scheme, Chanos says this: “If you take as a definition of fraud as intent to deceive…one can make a pretty strong case that an awful lot of multi-level marketing companies are built on the concept of selling opportunities to their distributors. But the facts of the matter is those opportunities are rarely achieved. It’s a pretty flawed business model.”

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