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A well-known American short-seller is betting against Manulife Financial Corp., arguing that a lawsuit the insurer faces could put it at risk of significant financial damage.

Run by Carson Block, Muddy Waters LLC on Thursday revealed a short position in Manulife. The short-seller hopes there will be a drop in the Canadian life insurance giant’s share price if it loses a little-known lawsuit launched by a hedge fund.

In a statement, Manulife rejected Muddy Waters' assertions that they could lose the trial or that its business was in any danger. Muddy Waters is best-known in Canada for a successful bet against Sino-Forest Corp. in 2011. Manulife’s stock declined 2.8 per cent on Thursday, ending the day at $22.54.

The lawsuit pertains to a 1997 universal life insurance contract that was originally held by a doctor but purchased by hedge fund Mosten Investment LP in 2010. Universal life contracts were popular in the 1990s, and they offered policyholders a payout upon death, as well as investment returns throughout the life of the contract.

Mosten argues the terms of the contract allow it to deposit an unlimited amount of money with Manulife and receive an annualized guaranteed return of at least 4 per cent.

If Mosten wins, Manulife could be on the hook for the gap between its own investment returns, and what the return it is legally required to pay the hedge fund. Insurers typically hold a large portion of their money in government and other fixed-income investments, which currently pay returns under 4 per cent. This means the hedge fund has the potential to earn significant returns at Manulife’s expense.

"The market appears to be unaware of this, and therefore, has not priced it in,” Muddy Waters alleged. However, the short-seller also acknowledged this outcome is far from certain, saying "it is extremely difficult to handicap a trial.” Neither Mosten or Michael Hawkins, whose name was added to the contract after it was acquired in 2010, could be reached for comment.

In its rebuttal, Manulife has argued the contract at hand was never marketed for use as an investment account. Manulife also argued that any investment returns could only be used to help offset premiums the contract holder would pay.

In a statement, the insurer said “the Muddy Waters report is a short seller’s attempt to profit at the expense of our shareholders, and we disagree with its conclusions. Manulife continues to believe that Mosten’s position is legally unfounded.”

Manulife added the company believes that “the consumers purchasing universal life policies, and the insurers issuing these policies, never intended to have the policies function as deposit or securities contracts.”

Historically, Muddy Waters is known for alleging fraudulent or bad behaviour, and then betting that a company’s stock will fall in the aftermath.

In the seven years since the Sino-Forest victory, activist investors and short-sellers have become more aggressive, often teaming up with hedge funds to announce aggressive accusations – some of which do not pan out.

In an interview, Mr. Block said he has no financial relationship with Mosten. Asked why he has taken on this cause, considering there are no allegations of fraudulent behaviour, he said: "Sometimes the fraud thing gets a little bit old.”

Mr. Block also said that as a lawyer by training, he finds the court case “intellectually stimulating.” “I always admire the guys that find these things that fall through the cracks,” he added.

Manulife is not the only insurer battling Mosten in court – Industrial Alliance Insurance and Financial Services Inc. is also being sued by the hedge fund. For both insurers, the contracts in question were issued by predecessor firms that they acquired.

Mosten and some partners invested more than $4-million in the Industrial Alliance contracts over three years, but the insurer reportedly halted the activity in 2016. Industrial Alliance did not return a request for comment.

At Manulife, tens of thousands of dollars were invested by Mosten in 2015, and the insurer returned the money in 2016.

Follow Tim Kiladze on Twitter: @timkiladzeOpens in a new window

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