Fooling Some of the People All of the Time, a Long Short (And Now Complete) Story, Updated With New Epilogue (28 page)

Three weeks later, on May 12, 2004, Allied held its annual shareholder meeting. At the end of his prepared remarks, CEO Walton came at the short-sellers once again:

Now I would like to switch gears. I think any people who read the [
Washington
]
Post
probably are aware that we have some people in the market who don’t necessarily agree with everything we do. I guess that’s part of being public. It is a phenomenon, which not only affects us but I think many public companies.

But in our case, two years ago we became the target of a misinformation campaign, which we believe was initiated by short-sellers attempting to profit by putting downward pressure on the stock through the use of such misinformation.

In the last several weeks that campaign has once again manifested itself. This seems to be part of a standard playbook used by people who call themselves event-driven investors who distort or, in some cases, simply make up information to manipulate the market. The pattern is pretty clear—take short positions and then do anything in their power to engineer an outcome in their favor. This manipulative activity harms shareholders and ultimately harms the whole capital market.

We’ve watched this activity for the last couple of years. We’ve watched this not only with us, but we believe it has been used with hundreds of companies. There’s a pretty clear pattern to this game. Let me tell you what we see are the ten steps in the short sellers’ playbook. Not quite David Letterman’s Top Ten, but it’s somebody’s top ten.

Anyway, you
first
identify a company which is highly regulated or complicated. We happen to be complicated and we are regulated.

Second
, find some fact. It doesn’t matter if it is material or not. Find a way to take the fact out of context or distort it so it has little or no relationship to the truth and make it sound sinister and quite material.

Third
, take your short position.

Fourth
, search out what we call research analysts, regulators, long investors and the press and tell them something bad is afoot. And, oh, by the way, don’t call the company to get the real story. Nobody has called us . . . I mean not in any material way and call the company. Don’t call the company to get the story. It will only get in the way of the distortion.

Fifth
, attack the credibility of management in anonymous chat boards is the usual way to do this.

Sixth
, create the illusion of a groundswell of concern. Get the short-sellers in a syndicate, call the SEC, research analysts, long investors, and press, and repeat your lies and distortion. If you do it enough and do it well, you can marshal powerful tools to bring about your outcome. Unknowingly, they become part of the game.

Seventh
, get a class-action lawsuit. More sure to follow.

Eighth
, go on the road and get every short-seller to pile on and pressure the stock down.

Ninth
, keep reminding everyone that the shorts uncovered Enron. They are the smartest investors in the world, and if the company fights back, it must have something to hide.

Tenth
, if everything goes according to plan, the stock goes down and you profit. And, as an added bonus, and this is their favorite part, if people figure out this is a game, go long and you ride it back up. And we have seen people coming out of our stock over the past two years who have played this game several times.

But we think the game has gone on long enough and it has got to be exposed for what it is. We believe our shareholders have been harmed, and it has interfered with our business. When we started this two years ago, or when this started two years, we believed that if we continued to correct the record and run the business we were doing the right thing for our company and the shareholders, but the manipulation has continued.

Let’s understand where, who is behind this. These event-driven investors manage large pools of capital funded by wealthy investors, and their activities are completely unregulated and undisclosed. It’s undisclosed and we believe it is damaging the investment savings of retail investors whether you invest directly or whether you invest through a fund. There’s no transparency as to this trading activity and the financial motives. You can freely manipulate or freely execute the manipulation game without detection.

The most recent attacks, the well publicized $9 million BLX loan transfers generated a profit for those short the Allied story. Our accounting and disclosure surrounding this transaction were completely appropriate.

Sooner or later, the facts and the truth will prevail over the misinformation and innuendo. We proved that two years ago, and we will continue to provide proof through performance. But we are also going to work to expose the market manipulation activity whenever it occurs, and we’re looking at every option available to us to protect the company and your shareholder value. We have a great company and a great future ahead of us.

In the two years since the speech, Greenlight had its own good performance. We survived a real bear market in 2002, with the S&P 500 falling 22 percent and the Nasdaq an even more vicious 31 percent, and we came out with a positive 7.7 percent return. The Allied short generated a 21 percent return on capital, and we made all our profits that year on our short sales. It was the first year we were not profitable on both longs and shorts. Eleven of our fifteen most profitable investments were shorts, as the short portfolio returned 65 percent on its capital invested. We needed them because we suffered large losses in long positions, particularly WorldCom and Tenet Healthcare.

The market turned up in 2003 and Greenlight returned 36.8 percent, with all the top fifteen winners being longs and the top seven losers, headed by Allied, being shorts. Our five largest longs heading into that year each went up at least 78 percent, which made Allied’s 38 percent rise manageable. In fact, Allied went up slightly less than the rest of the short portfolio. It was a broad bull market with the S&P 500 advancing 28 percent and the Nasdaq rallying 50 percent. We ended the year with $1.8 billion under management.

As the months passed, we realized that Eichenwald had not made progress on a larger story. He was focused on his Enron book, and although he told us that he remained interested in the Allied/BLX story, we asked him to free us from the exclusive. He agreed, saying that he wasn’t going to get to the article anytime soon. That was a big disappointment because we had given him a valuable exclusive for eight months.

We decided to approach
The Washington Post
, because the story of Allied, as a Washington, D.C., company abusing a federal agency, seemed natural for the newspaper. Steve Bruce, Jock Ferguson from Kroll, and I met with the reporters Jerry Knight and Terrence O’Hara. I had spoken to Knight three years earlier about Computer Learning Centers, another local company. He remembered, and I thought that would help me get the benefit of the doubt. Both had written about Allied previously. We met in a conference room next to the newsroom and spoke for about three hours. Ferguson and I made the same presentation that we made to Eichenwald and gave the reporters supporting documents.

Unlike Eichenwald, though, they didn’t seem interested in reading anything. Actually, they were politely dismissive. Their message to us was, “Grow up—fraud at the SBA happens every day. Why should anybody care?” It seemed odd to me that
The Washington Post
would be so dismissive of a government-related fraud conducted by a local company. This seemed to be their beat.

“Do you know if the SBA is going to do anything?” O’Hara asked.

“We’ve given them the same information we’ve given you,” I said. “Hopefully, they’re going to pursue it.”

As it turned out, this was the first of a number of meetings we initiated with a “Who’s Who” of the financial media. Each declined the story in one of three ways. Some were like
The Washington Post
—that is, if we could show them that the government was cracking down, that would be news. Otherwise, they weren’t interested. The second group would indicate that so much had been written about Allied and Greenlight that they didn’t see what was new. We would respond that all the previous coverage was “he said, she said” and invited them to spend some time, independently research the facts—for which we could provide a road map—and determine for themselves and their audience whether Allied had acted badly. The third group would act as Eichenwald did initially. “I can’t believe this. How could everyone else turn this down? We need to do more stories like this!” For this last group, months would pass. Inevitably, we would hear that they would get to it after they completed some other project. They never got to it.

Certainly, one of the biggest things I have learned from the Allied experience is the surprising reluctance of the media to dig into complicated financial stories. Even if the story is served up on a silver platter, there is not much interest. We needed someone able to do more than talk to us, talk to Allied, he said, she said. This story required investigative journalism. When Allied and we disagreed, someone needed to be willing to spend time, do the work, and come to an independent view on this complicated debate. There was simply nobody in the business press willing and able to do this.

On June 23, 2004, David Armstrong from
The Wall Street Journal
left me a message late in the afternoon, after I left for the day. He also called Bruce. By the time Bruce located me, it was too late to reach Armstrong before his deadline. It turns out that Allied had been notified it was under investigation by the SEC after all. Rather than announce the bad news themselves, again, they gave Armstrong, crusader against hedge-fund evil, the story. It was no surprise that Armstrong didn’t reach out to me until after business hours. Armstrong’s story positioned the announcement of the investigation as regulators paying heed to some noisy short-sellers who had been attacking the company for years. It was almost positioned as good news for Allied to have an opportunity to achieve vindication.

Allied put out a release confirming the SEC investigation. According to Walton:

Over the last two years, we have consistently refuted frivolous allegations made by short-sellers based upon false and misleading information and distorted facts. We welcome the opportunity to fully cooperate with the SEC, provide all the facts, and demonstrate once and for all that the short-sellers’ allegations are false. Allied Capital is a great company and as the facts are understood we expect to put this short attack behind us.