A famed short-seller’s negative report on one of the litigation finance industry’s most high-profile firms has attracted scrutiny to the sector — something one consultant says is overdue.
Short-seller Muddy Waters Capital announced Wednesday that it is shorting litigation finance firm Burford Capital for its accounting practices. Burford, which has offices in New York, London, and Chicago, responded the next day, defending its policies and offering up detailed explanations for how its accounting works.
Its share price dropped precipitously, then spiked on Friday as investors tried to digest the news. The report comes roughly nine months after Burford announced that it had raised $1.6 billion to make new investments in litigation funding.
While the battle between Muddy Waters and Burford will continue in weeks ahead, it signals an underlying issue in the industry, according to Charles Agee, managing partner at litigation finance consulting firm Westfleet Advisors.
“What I hope this will trigger is a realization in the industry, at least the U.S. industry, of the need for standardization,” said Agee, speaking by phone Friday. He added that the industry does not yet have a set of best practices either for accounting or for making investments, which could lead to trouble.
Litigation finance firms bankroll lawsuits and then take a cut of the winnings if their clients prevail.
Muddy Waters claims that Burford is “egregiously misrepresenting” its return on invested capital and internal rates of return.
The firm uses different accounting procedures than most in the industry, according to Agee, who said Burford is unique in its approaching to accounting and asset valuation. Agee, who used to run his own litigation finance fund, said he and others he’s worked within the industry tend to carry their investments at cost. In other words, a $5 million investment is accounted for like a $5 million investment.
Burford uses a fair-market value approach, which means it uses its own formula to assign the investment value, Agee said. A spokesperson for Burford noted that private-equity firms like KKR and Blackstone use return on invested capital and internal rates of return on capital as well.
Agee noted that Buford’s approach is different than industry peers, but given that it's audited by a “big-four firm,” he said that “there’s nothing wrong with the approach.”
Following the release of the Muddy Waters report, Burford launched an investigation into market activities surrounding the time of the Muddy Waters report, a spokesperson said via email Friday.
“We are strongly suspicious that Tuesday’s significant fall in the share price was based on such actionable misconduct,” the spokesperson said.
“The only manipulation is that of Burford’s return metrics, accounts, and disclosures,” Muddy Waters founder Block said in an emailed statement to Institutional Investor.
Meanwhile, Bronstein, Gewirtz & Grossman is investigating shareholder claims that Burford has “violated federal securities laws,” according to its website. When reached by phone, the firm declined to comment.
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According to Agee, for litigation firms in the United States, there is no existing, formal industry group that could self-regulate litigation finance firms, despite the fact that most U.S. market participants would welcome one.
“I think the failure of the U.S. participants to do something like that just invites outside regulation,” Agee said. “Opponents of the industry are going to try to muddy the waters, no pun intended, between the accounting issues and other issues that come up.”