Fooling Some of the People All of the Time, a Long Short (And Now Complete) Story, Updated With New Epilogue (19 page)

He told us on the phone, “Things were requested of me as CEO that I resisted vehemently and I documented this to protect myself . . . I was asked to do things that violated GAAP. . . . I can’t give specifics, but it was nothing that could be debated. . . . Our CFO sent a sternly worded memo [to Allied] that said it was a black-and-white issue.”

Wichmann indicated that Allied wanted to sell Redox. He suggested that we pose as a buyer of the company and discover evidence of Allied’s malfeasance during our due diligence. I had no appetite for that. Instead, I informed the SEC of Wichmann’s story and hoped it would discover what Allied had tried to do. I have no idea if the agency ever followed up. Rather than having a conversation with the authorities, more and more it felt as if we were “having” a monologue. I worried that the audience had dozed off.

PART THREE

Would Somebody, Anybody, Wake Up?

CHAPTER 16

The Government Investigates

Late in 2002, I received a cold call from Kroll, the private investigation firm, which recently started a group to provide field research for money managers and wanted to pitch its services. Kroll impressed me and sparked the idea that a good public-data search and some active feet on the ground could aid our research on Allied. We hired Kroll to look into two of the Allied investments that were troubling us: BLX and American Physicians Services (APS). I wanted an independent third party to look into what was happening at BLX.

Allied’s pattern of investment and valuation made its APS investment suspicious. The investment started in 1999 as a $16 million investment in debt securities, preferred stock and warrants. In December 2000, Allied wrote-down the preferred stock and warrants to zero, signaling a problem. In the second quarter of 2001, Allied increased the investment to $40 million and reclassified the prior equity components of preferred stock, convertible preferred and warrants into common stock. Though this suggested that APS had been recapitalized, Allied continued to value its debt investment at cost. The history looked suspect, so I asked Kroll to see what it could find out.

Just as Kroll began its work in December,
The Wall Street Journal
reported that Eliot Spitzer, the New York attorney general, would investigate Gotham Partners, a hedge fund run by David Berkowitz and Bill Ackman. Specifically, Spitzer wanted to see whether Gotham intentionally manipulated stock prices by publishing research discussing its investment opinions. Prior to Spitzer’s investigation, Gotham announced it was closing, having suffered a mildly disappointing performance while concentrating its portfolio in illiquid positions. Gotham had a thin investor base, and when a few key investors lost patience, Gotham had to either sell all of its liquid securities to meet the redemption requests or shut the fund to achieve an orderly wind-down of the entire portfolio.

Because selling the liquid part of the portfolio would unfairly prejudice the remaining investors by leaving them with disproportionate stakes in the illiquid holdings, Gotham did the right thing by shutting down. I spoke with Gotham often because I thought highly of its principals. Though our styles were different, we had some overlapping positions, including short sales of MBIA and Farmer Mac, about which Gotham had published compelling analyses. My immediate reaction was that this type of investigation would have a chilling effect on the sharing of ideas among investors.

In an e-mail to another manager, I wrote, “It seems that at the end of the bear market, people would love to blame short-sellers for the misery. The establishment is very anxious to blame the corporate malfeasance on the ones that have already blown up (Tyco, WorldCom, Adelphia, and Enron) and hope that by everyone swearing that the financials are accurate and putting the known bad guys in jail, that it will all go away. After all the talk, the SEC doesn’t have funding. The Bush Administration doesn’t want the SEC acting as a tough cop. Try to get
The Wall Street Journal
to write a scandal story where there isn’t already blood in the water. They won’t do it. Even ‘Heard on the Street’ goes nowhere that could expand the scandal culture.”

Many investors share analysis and opinions on both longs and shorts. This discussion and debate helps make the markets efficient. I never considered that publicly sharing Greenlight’s research, particularly because it clearly disclosed our short position, was likely to provoke regulatory interest. Just to be safe, though, we removed our Allied analysis, the BancLab report, and my
TheStreet.com
article from our Web site. We thought it was a shame, but we did not want to invite extra attention as the world looked for bear market scapegoats after three tough years.

We held our seventh annual partner’s dinner on January 21, 2003. This dinner was unusual because instead of enjoying meeting with our partners, I spent much of the cocktail hour off to the side on a borrowed cell phone answering a series of pointed questions from David Armstrong, a reporter from
The Wall Street Journal
. I had never spoken to him before, but I knew who he was. He had recently written an article about hedge funds shorting retailer JCPenney that caused a minor uproar in the fund community for its heavy-handed, anti–short-seller slant. The story blamed short-sellers for causing a decline in the stock by working with class-action lawyers. Armstrong’s story failed to broach the possibility that JCPenney’s stock might have fallen because it twice announced disappointing earnings during the period in question.

We had recently hired Abernathy McGregor, a public relations firm, to help with the media relating to our buyout of Greenlight’s original partner, Jeff Keswin, at the end of 2002. With Abernathy’s help, and Greenlight’s lawyer’s input (he happened to be with me at the dinner), I answered Armstrong’s questions about Allied, MBIA, and Greenlight’s relationship with Gotham. Armstrong thought Gotham was a large investor in Greenlight and implied that Gotham’s wind-down would cause it to redeem its investment in Greenlight and put Greenlight at risk. That was not true—Gotham wasn’t an investor in Greenlight. He also asked if I had heard from Spitzer’s office or the SEC. I hadn’t heard from any regulators. He wouldn’t say why he asked.

I have no idea how I got through my hour-long presentation to our partners and another half hour of questions that evening. I worked into the presentation my views of regulators looking into investors sharing ideas and noted that we received a related press inquiry. When I got home that evening, I checked
The Wall Street Journal
’s Web site and saw that there was an article set to appear in the next day’s paper. Armstrong and two other reporters wrote that the SEC and Spitzer would look into Gotham Partners Management Co., Tilson Capital Partners, the Aquamarine Fund, and Greenlight to see if we conspired to manipulate stock prices by publishing research and asking critical questions on conference calls. While I knew Gotham well, I had met Whitney Tilson only briefly and had never even heard of Aquamarine.

I knew we hadn’t done anything wrong and believed it appropriate to share investment analysis and opinion, positive or negative, about companies and ask challenging questions on conference calls. Everything we said or wrote about Allied was a combination of fact and good-faith belief. I had even asked Allied in writing to identify factual errors and promised to publicly correct any mistakes. How could it be manipulative to tell the truth?

With that in mind, I began to wonder how Armstrong knew about the investigations. I believed then and do now that the story started with a leak from Spitzer’s office. Spitzer may have accomplished many good things as attorney general; however, his office was well known for leaking the subjects of its investigations to the press prior to finding actual wrongdoing, a practice at odds with the grand jury system and prosecutorial ethics that enables the authorities to investigate possible criminal activity without the identities of the subjects becoming public until an indictment is delivered. Under this system, if the investigation does not turn up a crime, reputations are not harmed. In this case, I believe Spitzer sought headlines to bolster his image as a crime fighter—now taking on hedge funds—before he determined whether any crime had been committed.

The next morning, many of our partners began calling to find out what was going on. Some were nervous, but there wasn’t much more we could tell them because we didn’t know more than what the newspaper reported. No regulator had contacted us, and we had no way to know if we would hear from them. So we decided we had to adopt a “no comment” policy. We knew that we had done nothing wrong, but we didn’t want to update some partners and not others. The right way to update everyone would have been in writing. However, written correspondence has a way of getting into the media, and development-by-development updates could begin to spiral out of control. A fraction of a percent of our partners asked for their money back, but many called to express support. We had always been open with our partners on almost any topic other than what we were currently buying or selling. The “no comment” policy was tough on us, and it was tough on them. However, minimizing the media circus was in our mutual interest.

Allied, however, went running to the press.
Bloomberg
reported that Allied requested the investigation the previous week. Abernathy released a statement from me, saying, “We wish companies would address valid business issues, rather than attacking investors who raise them. We stand by our research on Allied Capital and would welcome a meaningful discussion with management on the facts.”

I raised the subject of a discussion with management because Allied’s management no longer even pretended to engage in the discussion. Management had recently come to New York for a “road show.” These are a series of one-on-one and group meetings for investors, often sponsored by investment banks. Some road shows are in connection with a securities offering, while others are called non-deal road shows. At its recent road show, Allied refused to permit us to attend. Even more, they refused to allow
any
hedge funds to attend. They were only willing to meet with long-only investors. Putting aside the issue of fair access to information, Allied quite simply didn’t want to be faced with any pointed questions. Over the subsequent years, Allied has maintained its policy of refusing to meet with hedge funds. In fact, one time it announced a one-day road show to be followed by an overnight stock offering led by Citigroup. Citigroup was unaware of Allied’s policy and scheduled management to come to our office and then to another hedge fund’s office. When Allied’s management saw the schedule, they canceled both meetings. Other times, various brokerage firms have hosted group events for Allied to meet investors. As a client of the brokerage firms, we have been invited to attend—only to be turned away at the door at the direction of Allied management.

On Friday, January 24, 2003, two days after
The Wall Street Journal
article, we received a letter from the SEC addressed to Greenlight Capital, LLC, referencing “In the Matter of Federal Agricultural Mortgage Corp.” (Farmer Mac). The SEC advised us of an informal inquiry and asked us to produce our research on Allied, all contacts we made to third parties about Allied and our research file on Allied. They also wanted all of our trading records, organization chart, contact information for all Greenlight employees and all documents to describe our compensation structure, a list of our bank and brokerage accounts, and our telephone records. They wanted all this information going back to January 1, 2002. The letter requested voluntary production of the information by the following Friday. Greenlight’s lawyers worked with the SEC to get more time, and we produced the information as promptly as we could.

The
Journal
article not only hurt my company’s reputation, but it also affected my wife. About a week after the article appeared, Cheryl was fired from her job as a writer and editor at
Barron’s
, the weekly financial magazine owned by the
Journal
’s publisher. Her boss told her that they had huddled with the company lawyer, who suggested that they part ways with Cheryl until the investigation was over. He told Cheryl that they were worried about appearances. “It’s difficult to be married to someone in the investment business,” he told her. She had worked there for about ten years. It was a bad few days. It is never a good thing to get your spouse fired.