Fooling Some of the People All of the Time, a Long Short (And Now Complete) Story, Updated With New Epilogue (24 page)

The OIG concluded that BLX’s actions “were egregious acts and warrant SBA action to seek civil fraud remedies against the lender.” The company’s failure “to follow prudent lending practices, and materially comply with SBA requirements, undermined the integrity of the Section 7(a) business loan program.” The OIG recommended suspension of BLX’s PLP status in the Georgia District Office “due to its failure to comply with SBA regulations, policies and procedures for originating loans.” In addition, BLX had to repay the nearly $750,000 reimbursement to the SBA. Ultimately, the SBA did not pursue civil fraud remedies or suspend BLX’s license in Georgia. As we would see many times, the SBA has been strangely forgiving of BLX’s misdeeds.

Even some former BLX employees whom Kroll interviewed were amazed at how the company conducted its business. “It was appalling how BLX operated,” one former BLX executive told Kroll. “They had poor underwriting talent, no proper training (and), because there was no regulator overseeing them, they assumed the SBA would never look at them. They were pure sales people who never saw a bad loan deal. It is a recipe for disaster.”

Former BLX employees also indicated that the company rushed to produce loans because the compensation of senior executives was tied to the volume of new loans. They also said that BLX would keep impaired loans that were in foreclosure or bankruptcy on its books so they wouldn’t have to be written off. “It is clear that BLX is hiding its actual loan losses from Allied shareholders,” a former BLX employee told Kroll.

Around this time, another of Carruthers’s sources told a story from his tenure at BLX. The ex-employee believed that BLX should take a $10 million write-down for bad loans. BLX didn’t want to do it. The employee approached Robert Tannenhauser, BLX’s CEO, and advocated the write-down and said the appraisals didn’t support the carrying values.

Tannenhauser’s response: “F**k the appraisals.”

CHAPTER 20

Rousing the Authorities

Greenlight’s law firm, Akin, Gump, Strauss, Hauer & Feld LLP, arranged meetings in August 2003 with the SBA, the SEC, and New York Attorney General Spitzer so that Kroll could share its report. At the SBA meeting at its office in Washington, D.C., Jock Ferguson, who led Kroll’s field effort; Rich Zabel from Akin, Gump; and I met with David R. Gray, counsel to the inspector general of the SBA; Robert Seabrooks, assistant inspector general for auditing; Mark R. Woods, assistant inspector general for investigations; and Garry Duncan, with the Atlanta field office.

As we laid out a number of fraudulent transactions, they seemed drowsy.

“Do you have the SBA loan numbers for these loans?” one of them asked.

“No, we don’t,” Ferguson said. BLX’s delinquency report was not indexed by SBA loan number. The legal records supporting Kroll’s research didn’t contain them either.

One of them asked, “Do you know how we could get those?”

Was the SBA really asking outsiders how to obtain its own loan numbers? Apparently, giving them the borrower’s name and address wouldn’t do.

I wanted to scream, “Send them a subpoena!” Instead, I said, “Why don’t you ask BLX?”

Ferguson walked through the loan frauds and pointed out the lack of equity injections. One of the SBA guys said, “We see this all the time; what is special about these?” It was as if they were well aware that no one actually follows the rules.

This wasn’t a group of government investigators likely to work overtime. The meeting’s high point was when they bragged they actually recovered about $5 million from Allied for bad loans earlier that year. Obviously, that was news. I had no way to know that half a year later this nugget would resurface.

I was naïve enough to expect that the SBA would actually take an interest. Here, we had spent private resources and laid out an easy road map to show an ongoing fraud that was costing taxpayers at least tens of millions of dollars in guarantee payments on loans that should never have been made and served no purpose other than to line the pockets of crooks. The SBA has limited resources; we were offering free help and were obviously willing to provide additional help, if asked. Most perplexing—the folks we were meeting with had presumably chosen careers in public service to root out
exactly
this sort of misconduct, yet seemed unwilling to do anything to stop it.

Ferguson told them that he had a list of sources that could help them in their investigation. We suggested that someone from the SBA follow up by calling Ferguson to obtain the list. No one ever did.

Ferguson followed up with one of the SBA officials. He learned that the SBA agreed with Kroll’s assessment of the Mangu Patel loans. In April 2004, Ferguson sent us this update of one conversation with an SBA official:

The OIG [Office of Inspector General] has had difficulty obtaining internal SBA computer records on all the loans listed in BLX’s Delinquent Loan Report dated August 8, 2001.

The loans in the 113-page BLX document did not have SBA loan numbers attached to them and it became impossible for the OIG to find them in the SBA computer database. Then the SBA discovered that the database for August 2001 was no longer available.

Recently a former SBA loan officer has been hired by the OIG to investigate the status of BLX delinquent loans. That person has begun two different investigations of BLX loan records, the SBA source said.

She is looking at the current status of BLX loans to assess whether or not the SBA is being properly notified of the loan status once it becomes delinquent.

In addition, the same person is looking at all the loans in the BLX August 2001 Delinquency Report to determine what the SBA was told about their status and when.

One of the early findings by the SBA is that proceeds of the delinquent loans were improperly used. “We are finding a lot of problems,” the SBA source said.

At this stage, there is only one OIG staff member investigating the BLX loan portfolio status because of a shortage of personnel.

Putting a person on it and finding a lot of problems was a good sign. Perhaps the SBA was slow—a turtle to our hare—but would get there eventually. However, if the investigators were having trouble with the SBA loan numbers and that particular delinquency report, why didn’t they call BLX and ask it to send over every monthly delinquency report for the past couple of years? And further, ask BLX to index the reports to the SBA loan numbers?

The lack of resources was not a trivial concern. The SBA is more than fifty years old. It was created during the Eisenhower administration with the passage of the Small Business Act in 1953. Its goal is to help small businesses compete.

Under the SBA, loans would come from private lenders, not directly from the government. Instead, the government acts as the loan guarantor. It charges a guarantee fee on each loan, which it uses to pay the majority of the losses on the loans that default. However, if the losses run in excess of the guarantee pool, taxpayers are on the hook.

The SBA 7(a) lending program is the SBA’s largest business loan program. At the onset of the program
,
SBA rules required it to approve every loan before it was issued. In an effort to speed things up, the agency created the Preferred Lender Program (PLP) in 1984 to delegate much of the SBA’s decision-making authority regarding loan approval, loan servicing, and liquidation activity to lenders who have demonstrated thorough knowledge of the requirements. In 2003, the 7(a) program guaranteed $10 billion of loans to 60,000 businesses.

While the PLP made the lending process quicker, more efficient, and less costly to the taxpayer, the government, in effect, turned over its underwriting pen to private enterprise. One would think that the SBA would dedicate
some
of the resources it saved by not having to review every loan to ensure it doesn’t get ripped-off. Not so.

The majority of the 7(a) loans are made in the PLP. As part of its oversight function, Congress had asked the United States General Accountability Office (GAO) to evaluate the SBA’s lender oversight. In December 2002, the GAO reported that the SBA contracts with outside firms (inappropriately paid for by the lenders being reviewed) to evaluate the PLP lenders. The GAO found that the evaluations do not make a qualitative assessment of the lenders’ decisions but, rather, are only a cursory review of lenders’ processes and documentation maintained in a sample of the lenders’ loan files. According to the GAO report, the SBA does not adequately measure the financial risk PLP lenders pose to its portfolio. The report indicated that the SBA lacks resources to properly monitor lenders. The office of lender oversight had only twelve staff members overseeing over four hundred preferred lenders, one of them being BLX. There was only one staff member assigned to portfolio analysis and reporting in the entire SBA program.

The GAO report observed that “PLP reviews are not designed to evaluate financial risk, and the agency has been slow to respond to recommendations made for improving its monitoring and management of risk—posing a potential risk to SBA’s portfolio. PLP reviews are designed to determine lender compliance with SBA regulations and guidelines; however, they do not provide adequate assurance that lenders are sufficiently assessing eligibility and creditworthiness of borrowers.”

The SBA reviews lenders through a questionnaire and checklist that generally reviewed the presence or absence of documents in the lender files. Reviewers “are only required to review loan files for completeness and required documentation. Review staff rely on the lender’s attestations rather than independent assessment of loan file documentation.” In short, it’s a check-the-box review without any substance.

“SBA officials said that lender review staff focus on the lender’s process for making credit decisions rather than the lender’s decision. SBA officials said that it is unlikely that the review would result in a determination that the loans should not have been made. An SBA official stated that review staff would not perform an in-depth financial analysis to assess the lender’s credit decision and that a lender’s process would only be questioned in the case of missing documentation. . . . This official said additional training would be required for lender review staff to make more qualitative assessments of loan documentation during the review process.” The report concludes, “Without a more substantive method of evaluating lender performance, this approach does not provide a meaningful assessment.”

Allied touted that BLX routinely received the highest ratings in its PLP audits. Apparently, this equated to good filing technique and the ability to attest to compliance when the poorly trained, government-contracted reviewer came calling. Even if it stumbled onto a problem, the GAO found that the SBA hadn’t even established procedures to suspend or revoke PLP authority. In fact, there were no follow-up procedures for PLP lenders that received poor reviews. Because the SBA wants to encourage lenders to participate in the PLP program, it chose to “work out problems with lenders, and therefore rarely terminate PLP status.”

With this regulatory framework, it wasn’t hard to see how a team of bad guys could bilk the government and taxpayers for big dollars. As Kroll noted, “Senior BLX executives know they can flout SBA rules because there is no effective oversight or regulation of PLP lender practices. In effect, the SBA has no idea of the quality of the loans that BLX is originating, whether BLX is in compliance with SBA rules and regulations or how its loan portfolio is performing.”

After our discouraging meeting with the sleepy-eyed SBA in the morning, we proceeded to the SEC’s headquarters that same afternoon. We met with two SEC enforcement officers, Charles Felker and Walter Kinsey. They walked into the meeting with blank legal pads and let us lay everything out. They took a lot of notes and seemed engaged in the presentation. As we moved from the wrongdoing at BLX to how Allied used BLX to inflate its own financials and made false and misleading statements to confuse the market, Kinsey asked for a
written summary
. He became frustrated that I didn’t have that information with me, and I promised to provide it in a follow-up package.

That the SEC meeting was better than the SBA meeting was a low hurdle cleared. As with the SBA, the SEC officers didn’t seem interested in obtaining the supplemental list of people with whom to follow up. Indeed, there was no evidence they followed up on anything from our meeting. When I returned to the SEC the following spring (as I will describe in the next chapter), the SEC had an entirely new set of lawyers, who expressed no knowledge of this prior meeting.

To complete the regulatory trifecta, we met Attorney General Eliot Spitzer on August 14, 2003, the day of the Northeast blackout, which shut New York City down shortly after we left. Spitzer took no notes, though he was attentive. He asked good questions, asked for a copy of the Kroll report, and promised to review it and get back to us. We left with some optimism that someone within a governmental office would jump on this. To my surprise, we never heard from Spitzer’s office again.

I sent the SEC a thirty-nine-page follow up letter and supporting analysis in October 2003. The letter covered a litany of our initial accounting criticisms and the change in Allied’s accounting. We included a statistical analysis to test Allied’s contention that it used a consistent valuation method. By comparing the percentage of investments that Allied changed in valuation from one quarter to the next, we were able to show, almost without a doubt, that Allied had indeed changed its portfolio valuation methodology.