Fooling Some of the People All of the Time, a Long Short (And Now Complete) Story, Updated With New Epilogue (32 page)

After Brickman tabulated the SBA data on BLX’s loan performance, he sent a second letter to Janet Tasker, the SBA lender oversight administrator, in December. The SBA set benchmarks for the maximum amount of delinquent loans (11 percent), defaults (9 percent), and loans in liquidation (7 percent) that a lender could have to remain in the program. Brickman estimated, using SBA’s definitions and methods, that the delinquency rate exceeded 17 percent, the default rate exceeded 13 percent (and could be closer to 17 percent under some assumptions) and the liquidation rate also exceeded 13 percent.

BLX was far worse than other SBA-backed lenders. Brickman calculated that about 13 percent of the SBA’s guarantee payments on defaulted loans nationwide were on BLX loans in 2004, despite BLX having less than a 4 percent share of national originations. Nonetheless, the SBA, again, renewed BLX as a preferred lender at the end of 2005. We passed the data showing BLX’s astronomical default rate to Jesse Eisinger at
The Wall Street Journal
. He wrote about it on December 28, 2005. Eisinger reported that Allied said that Brickman’s numbers were “wrong.” However, they weren’t materially different from Allied’s figures, which showed a default rate of 11.25 percent, a level still far in excess of the SBA’s 9 percent limit, even though the rate was depressed by including many recently originated loans that hadn’t had much time to default.

Eisinger reported that the SBA renewed BLX as a preferred lender by excluding the loans originated by Allied Capital Express, supposedly because Allied, rather than BLX, originated them. The agency also excluded the shrimp-boat loans, supposedly due to an industry-wide slump. As Eisinger put it in his article, “BLX also worked the refs, and the SBA kindly moved the goal post closer.”

I went to Atlanta in March 2006 and further discussed the shrimp-boat fraud with a larger group of Justice Department lawyers. (Brickman, again, went down separately in May.) The SBA also sat in on the meeting. I once again needed to explain who I was, what Greenlight was, and how BLX defrauded the SBA.

At the meeting, the investigator for the SBA’s OIG, Kevin Kupperbusch, asked me how we obtained so much detail on the shrimp-boat loans. He asked if we had the loan records. “No, we don’t have the loan files,” I said. The detailed information came from a variety of other sources. “You have to match stuff up,” I said, explaining that they needed to sit down and match up the loans to our allegations of specific lending violations. Our suit contained a laundry list of ways BLX flouted SBA rules: fraudulent appraisals, not properly collecting on the loans, making multiple loans to one borrower, not verifying the equity injections, and so forth. We included a disclosure statement with all this information when we filed the lawsuit, so the government had it. They just didn’t have it in the room we were sitting in.

As for the lack of a certificate from the National Marine Fisheries Service, Kupperbusch speculated that it might not be a problem, because he thought that the SBA decided in 1998 that a certificate was no longer required for a loan. Though the SBA’s standard operating procedure specifically required the letter, Kupperbusch implausibly suggested that, perhaps, the error was that no one bothered to change the regulation on the books.

Of course, BLX had been by far the largest originator of SBA shrimp-boat loans since that time. I wondered whether this might be just another SBA stonewall. Afterward, Brickman sent a FOIA request to the SBA asking for any records indicating the agency had changed the rule. The SBA’s response was that there were no records of any changes.

At the meeting, I tried to draw their attention to the pattern of abuse. BLX made many of the loans to Vietnamese-Americans. “There are forty-five loans to Nguyen at a particular address in Biloxi,” Kupperbusch said. “One of the things I have run into is that Vietnamese families often live on their boats and their address is the pier. They all use the same address. The SBA is very familiar with Na Nguyen. She had an insurance company there also. She is one of the few who are bilingual, and since the shrimpers may be out for a month at a time, when the lenders need to contact the boat operators, she is the intermediary.” Kupperbusch said the SBA officer he talked to said they don’t believe the Vietnamese fleet is one business, but rather a cluster of families. However, Kupperbusch acknowledged that there were multiple loans that went to the same Social Security number. He said he believed “that this was a good, solid allegation that may lead to criminal fraud.”

The meeting lasted for about an hour and a half. After it was over, the lead Justice Department lawyer walked me to the elevator and said that the SBA was pushing back hard against our complaint in a manner she’s never seen from a government agency. I asked her if the pushback was potentially corrupt. She said she didn’t think so, but the SBA sees itself as a “lender-friendly” agency.

Then she reminded me that the SBA was actually
her client
, but she was clearly bothered by its pushback.

As I left, she said, “As a taxpayer, this boils my blood.”

Mine, too.

In early September 2006, we received news that the Justice Department declined to intervene in our whistle-blower suit. It didn’t say why. I speculated that the SBA “pushback” had won the day. Although we were frustrated by this decision, we believed that the evidence was overwhelming that BLX violated the False Claims Act and caused tens of millions of dollars in damages to taxpayers. So we decided to continue the suit on our own.

The complaint was unsealed a few weeks later, and the judge ordered us to serve it on the defendants by the end of the year. Ordinarily, the statute gives 120 days, but the judge said that it had been on her time clock since 2005 and she wanted more progress. Our lawyers prepared an amended complaint, and with leniency from the judge, we filed and served it in January 2007 on the defendants Business Loan Express LLC, Robert Tannenhauser, Matthew McGee, George Harrigan, and (John) Does 1–100. Actually, it was hard to serve it on Tannenhauser. He avoided the process servers for several days and failed to meet them, even though he agreed on the phone several times to do so. Then, he took off on a vacation to Indonesia.

CHAPTER 24

A Naked Attack

On August 11, 2005, Patrick Byrne, the CEO of the Internet retailer
Overstock.com
, called Greenlight to speak with me. I was out of the office at a meeting, so the call was passed to Alexandra Jennings, our analyst who covered Overstock, although we had been out of the stock for months by then. We briefly held a small short position in Overstock that we closed out at a profit in January 2005.

When Jennings heard she had a call from Byrne, her antennae went up. About an hour before, Overstock had issued a press release announcing it was suing Rocker Partners LLP, a hedge fund that was short Overstock, and Gradient Analytics, an independent research boutique that published critical research about Overstock. Overstock claimed there was an improper relationship between the two. The announcement said there would be a conference call and Webcast the next day to discuss the suit.

Byrne introduced himself and asked for me. Jennings told him I was out of the office for the day.

“Do you follow us?” Byrne asked.

“I do.”

She didn’t elaborate, and Byrne seemed to stumble, waiting for her to say more, but she was too smart for that.

“Ahh, okay, well, just let David know I called. And he can call my cell if he has anything to talk about.”

“All right, I certainly will,” she said, and hung up.

That was an odd way to put it, saying if I had anything to talk about with him that I should call. He called me, so he obviously had something on his mind. If I had anything to ask Byrne, I would have called him myself.

He and Jennings spoke for only thirty seconds. Jennings had researched Overstock, including doing some “comparison shopping” on the site and building a spreadsheet, where she modeled Overstock’s performance. She performed financial analysis, including comparing the stock value of Overstock, which was a large number, with Overstock’s profits, a negative number. The spreadsheet also identified rising customer acquisition costs, which is not good. But she didn’t tell Byrne any of that.

I probably would have called him back, but I didn’t have a chance that day, and after hearing about the conference call the next morning, I decided to steer clear of him. So I never did call him.

But I did decide to listen to the conference call and could not believe what I heard. Byrne went on a bizarre tirade. He made a flurry of charges against so many people and organizations that it would be funny except it was really sad, because he actually
meant it
and some folks actually thought he was right.

“Even hardened denizens of Wall Street were shocked by a conference call that Patrick Byrne, the CEO of the retailer
Overstock.com
, held on August 12,”
Fortune
reported. “‘I want to get something off my chest,’ Byrne announced. Then he launched into a rant about a ‘Miscreants Ball’ in which he mentioned hedge funds, journalists, investigators, trial lawyers, the SEC, and even Eliot Spitzer.”

This book shows that this is the opposite of how it works. Nobody has cooperated with Greenlight.

According to Byrne, the conspiracy is run by someone he called the “Sith Lord,” in reference to the villain in the
Star Wars
movies. In Byrne’s own words:

As this went on I started realizing that there was actually some more orchestration here being provided, by what I’m calling here is the Sith Lord or the mastermind. Now, can I tell you who that designated bottom feeder was who was supposed to end up with our company? Can I tell you? I can. But I’m not going to today. The Sith Lord is, can I tell you who that is? Well, I could tell you it’s a name that everybody on the phone, every single person on the phone would recognize this person’s name. He’s one of the master criminals from the 1980s, and he’s back in business. But I’m not going to. I’ll just call him the mastermind today.

A few moments later, Byrne continued, “The man I’ve identified here as the Sith Lord of this stuff I just say, you know who you are and I hope that this is worth it, because if the feds catch you again, this time they’re going to bury you
under
the prison. And I’m going to enjoy helping.”

Though we were not part of his lawsuit, as Byrne went through his list of “miscreants,” first my name came up and a few minutes later my wife, Cheryl, joined the “Ball.” Byrne’s bringing me up in his public harangue was out of all context, except for one: Allied. Our fight with Allied had become so public that Byrne lumped me in with a cast of who he considered evil-doers trying to undermine perfectly good companies and ruining America.

“David Einhorn runs a fund in New York called Greenlight Capital,” Byrne said in about his only truthful statement about me. “Greenlight, I’ve been in Greenlight, and they told me sort of a founding myth of Greenlight, which was that David Einhorn was a Cornell guy who found some arb and traded it from his dorm room and that turned into Greenlight over time,” he continued.

Byrne had never been “in” Greenlight. I didn’t find an “arb” in college or trade it from my dorm room. This does sound like the story of Ken Griffin, founder of Citadel, who did just that at Harvard. It seemed that Byrne conjured up various stories and stereotypes about hedge fund managers and depicted me as an amalgamation of a bunch of them.

He next turned to Cheryl. “Then there’s
Barron’s
,” Byrne said. “And
Barron’s
, anybody on the ‘Street’ understands
Barron’s
more or less as just being a group of quislings for the hedge funds. . . . There has been until recently an editor there named Cheryl Strauss, married name Cheryl Strauss Einhorn, wife of David Einhorn. And if you trace the articles around, which I’m going to talk about in a minute, you’ll see that both entered these very odd relationships.”

This did not take a lot of detective work. At
Barron’s
, Cheryl always wrote and published as “Cheryl Strauss Einhorn.” Byrne went on to say that if people checked, they would find that a reporter who had recently written a negative article about Overstock in
Barron’s
probably knew Cheryl. That was probably correct, but so what? It was hard to tell because all he had was Joe McCarthyesque innuendo. Possibly, he wanted listeners to believe Cheryl fed a story to the reporter on our behalf at a time we weren’t even short his stock. In Byrne’s paranoid view of the world, reporters blindly accept assignments from former colleagues.

He also saw a conspiracy between Kroll and me. I guess Allied told him Greenlight had hired Kroll to investigate Allied and BLX loans. Now, according to Byrne, Kroll was investigating him. That’s all the evidence he needed to think this was my doing.

Byrne continued, “Kroll has been investigating me for a number of months, trying to come up with dirt on me. The general—well, I had trouble nailing that down until I discovered the personal relationship between Jules Kroll and David Einhorn.”

Though we retained the firm to investigate Allied, I have never met or spoken with Jules Kroll, the founder. Byrne seems to have made the connection because Kroll went to Cornell about twenty-five years before I did and also lives in the same town as my family.

Enter Jim Carruthers.

Byrne said:

Jim Carruthers is an interesting fellow. He’s up at Eastbourne Capital, north of San Francisco. Eastbourne has an “E” at the end. It’s funny because there’s a fellow holding himself out in a nearby location by the name of Jim Karruthers, with a slightly different spelling, holding himself out as a private investigator from Eastbourn Investigations, no “E” at the end. I know that couldn’t be this Jim Carruthers, because that would be a felony for a person to hold himself out as a PI when he’s not. And that PI has a very interesting relationship with a certain lawyer in Detroit, who has some very odd practices that maybe we’ll have time to get back to.

I suspect the part about the lawyer in Detroit referred to Carruthers’s getting information about the fraudulent BLX loans in Detroit. Plainly, Byrne spoke with Allied.

Before the show ended, he put my picture up on the screen next to a picture of David Rocker under the heading “Short-sellers.”

David Einhorn is the guy who is, of course, obsessive about his [security] concerns. They literally told me in Greenlight how he’s got six cell phones and swaps SIM cards and takes a different route to work. And when I was in Greenlight, they were explaining how you can’t even, I couldn’t even go into this part of the office and see him. He’s extremely shy and careful, won’t be seen in public, have pictures taken, anything like that. So if you ever see this man in public, do not take his picture because he’s evidently extremely concerned about it being known or on the Internet.

Again, Byrne has never been “in” Greenlight, nor has anyone at the firm met him. Obviously, there is no secret part of Greenlight where I hide. I own only one cell phone and didn’t know what a SIM card was until I asked someone after the conference call. Most days, I take a train to work, though I admit I don’t always come in at the same time. Pretty tricky of me. I was also unaware of an unmet demand or interest from people I don’t know to have my picture. I had no problem with Byrne having one, though.

I know all about CEOs of troubled companies lashing out at critics. I’ve had firsthand experience, but Byrne attacked anyone and everyone. It was a spectacularly bizarre performance.

Since then, Byrne has been on a crusade.
Overstock.com
even refers to it as the “CEO’s Crusade” on the Web site. Byrne’s big complaint is about what he calls “naked shorting.” Incidentally, his lawsuit against Rocker and Gradient has nothing to do with naked shorting. Presumably, in response to Byrne’s complaint and the related publicity, the SEC jumped into the fray to investigate these claims. The case made significant news when the SEC tried to force journalists to reveal their sources. The journalists refused and, ultimately, the SEC dropped the investigation.

Naked shorting is selling short shares that have not been borrowed. Byrne has made a big to-do about this by accusing hedge fund “miscreants” of driving good companies out of business. According to Byrne, a naked short is the equivalent of creating counterfeit shares and selling them on the market, thereby driving down stock prices. The SEC has listened to Byrne and other critics of the practice, eventually adopting rules in June 2007, making it harder to naked short. According to SEC Chairman Christopher Cox, naked shorting is a “fraud that the commission is bound to prevent and punish.”

The primary evidence of naked shorting is the large number of trades that don’t properly clear. These are called “failures to deliver.” I doubt there is a lot of naked shorting in the market. The practice is probably more widespread among market makers, who are permitted to short without borrowing the stock, and short-term traders, who plan to hold the position for such a short time that they will cover before the initial trade is due to settle. I don’t believe that research-driven short-sellers, who often hold positions for long periods, engage in much naked shorting. It simply doesn’t make sense, and the clearing brokerages don’t permit it.

However, there is an alternative explanation for the large number of failures to deliver. Suppose a shareholder lends his shares to a short-seller. The short-seller sells the shares to a new owner. The trades clear, and everything is fine. Now suppose the original holder sells his shares. His broker has to recall the lent shares to deliver them to the new owner. When the clearing broker for the short-seller gets the recall notice, instead of forcing the short-seller to immediately repurchase the shares in the market, the clearing broker looks for a new lender of the shares. It may take time to secure those shares. Perhaps the clearing broker has also lent shares and decides to solve the problem by recalling those shares. While the clearing broker looks for new shares to borrow or waits for his recall notice to be honored, time passes and the system can back up—creating failures to deliver.