Fooling Some of the People All of the Time, a Long Short (And Now Complete) Story, Updated With New Epilogue (47 page)

From April 30, 2002, through December 31, 2007, Allied returned 5.9 percent per year including tax distributions, lagging its benchmark, the Russell 2000 index, by about 2.2 percent per year, or about 15 percent cumulatively. As a short, it hadn’t been what I expected, but it hasn’t been a disaster, either. Greenlight’s overall performance remained quite strong, returning 17.7 percent per year during that same period.

Six years ago, I told the SEC about Allied’s aggressive, inappropriate, and illegal accounting. Five years ago, I told multiple government agencies about the fraud at BLX. Four years ago, I told the FBI that other Allied critics and I had our phone records stolen. Three years ago, I notified Allied’s Board in detail about its management’s misconduct and made a detailed presentation to the U.S. attorney in Washington outlining a variety of illegal activities. Two years ago, the USDA was notified about BLX’s pervasive fraud at that agency. One year ago, Allied admitted it had Greenlight’s and my phone records. Neither Allied nor any regulator has commented on the matter since. It is hard to imagine that an investigation should take so long, if Allied is, in fact, co-operating.

As of now, Allied continues its aggressive accounting. The government has not sought repayment for hundreds of millions of losses in its lending programs. No one at Allied has been prosecuted. Its management team remains in place—and has made tens of millions of dollars to boot. The good news is that this can change. The relevant parties—some combination of investors, government agencies, Allied officials or auditors, the media, and prosecutors—may still decide to remedy the situation. Count me an optimist.

PART SIX

Epilogue

CHAPTER 35

Looking Back: As the Story Continued

There are challenges in writing a book about a story without an ending. When I submitted my final draft of
Fooling Some of the People
to John Wiley & Sons in January 2008, the world was a very different place.

Allied was about to sell parts of its existing portfolio to Goldman Sachs for $170 million, with Goldman committing to at least another $125 million in future deals with Allied. To the public, our short was still a losing bet.

Business Loan Express (BLX) was still BLX, though only for a few more weeks. In an effort to distance itself from being associated with the largest fraud in Small Business Administration (SBA) history, BLX changed its name to Ciena Capital. (For simplicity’s sake I will continue to refer to it as BLX, even when referring to events that occurred after the name change.)

Our shrimp boat
qui tam
case had been dismissed on a technicality, but our appeal was still pending. We were also embroiled in another
qui tam
case
—
one that received no mention in the hardcover edition because it was still under seal
—
which I will detail in the upcoming pages.

Bear Stearns was not yet owned by JPMorgan Chase, Lehman Brothers stock was trading above $60 per share, and the worst financial crisis in history was still largely unimaginable to all but a few.

Much has changed since then.

BLX failed and Allied’s stock collapsed. I found myself embroiled in a similar (though much shorter, and less ugly) battle with Lehman Brothers. There, too, my analysis was proven correct.

These victories should be cause for celebration, but I take surprisingly little pleasure in them. I always believed that we would eventually be proven right with regard to Allied and Lehman. If anything, I feel somewhat more troubled now than I did then, because for all the things that have changed, far too many remain the same. And the stakes seem higher now.

Despite clear evidence of wrongdoing, there have been no significant consequences for Allied’s officers, directors, and auditors. Other gatekeepers who failed have not been held accountable. Though Allied’s shareholders have lost billions, almost everyone else
—
including Bill Walton and Joan Sweeney
—
gets to ride off into the sunset with their fortunes in tow. Robert Tannenhauser has even started a new small-business lending exchange for SBA loans. The regulatory systems in place still do more to reward bad behavior than to discourage it.

On the good side, the response I’ve received from readers has been endearing to me. I was
—
and continue to be
—
startled both by the sheer number of letters I received and by the gratitude expressed.

I found it amazing that strangers felt a need to write; I have never sent a letter or an e-mail to a book author. The sincerity in those letters stood in such stark contrast to the dog-and-pony show I’d come to expect between the various entities involved in the Allied debacle. I even appreciated the negative feedback. For everyone who took the time to write to me, or to write reviews on Amazon and various web sites
—
good or bad
—
I am genuinely humbled and grateful. The response has made my whole effort feel much more worthwhile.

CHAPTER 36

The Lehman Brothers Saga

In many ways, Lehman is the Allied story all over again. It starts with a speech, ends with a bankruptcy, and in between I am attacked by the company, vilified by the press, and investigated by the Securities and Exchange Commission (SEC). The system of gatekeepers
—
regulators, auditors, directors, the media, sell-side analysts, and rating agencies
—
failed with Lehman in the same way it failed with Allied.

The Lehman conflict was significantly shorter than Allied’s, lasting just over a year rather than most of a decade. Unlike Allied, the long-term ramifications of the collapse of Lehman have significant follow-on effects that will linger for years. More importantly, Lehman’s story serves as an even clearer example of what happens when the wrong behavior is rewarded in the short term.

The story gets interesting the morning after my presentation at the annual Ira Sohn conference for the Tomorrows Children’s Fund on May 21, 2008, but that is not where the story begins. On the morning of November 28, 2007, I gave a speech at the Value Investing Congress detailing my criticisms of Lehman’s leverage and accounting. The audience and the market were so taken with my concerns that Lehman shares
advanced
five dollars that day. On April 8, 2008, I gave a second talk focusing on Lehman at Grant’s Spring Investment Conference. I’d worked hard on this speech, pouring a lot of in-depth analysis into it. The market was similarly indifferent, but the speech itself was widely circulated, and Ben Stein, whom I’d never met, wrote a very flattering piece about it in
The New York Times
.

Erin Callan, the recently appointed CFO and public face of Lehman, took notice as well. With the collapse of Bear Stearns, Lehman had begun touting its transparency, so much so that on May 17, 2008,
The Wall Street Journal
did a profile of Callan, titled “Lehman’s Straight Shooter.” It reported, “To quash fears that Lehman could face the same kind of liquidity squeeze as Bear, Ms. Callan has had hundreds of face-to-face meetings and phone calls with investors and trading partners. She aggressively roots out rumors, even while pushing her bosses to disclose more financial information.”

The article was partly true. Indeed, Callan had had a phone call with me just the day before, though I found her answers less straightforward than one might expect from a straight shooter.

It is ironic that my presentation at the Sohn conference will always be known as “The Lehman Speech.” I had really just wanted to talk about
Fooling Some of the People
. The conference organizers generously bought copies of the book to hand out as gifts to all the attendees. They insisted, however, that I spend at least part of my time talking about a stock other than Allied. So after discussing the book, I offered my latest thoughts on Lehman, including some specific concerns I had about its most recent disclosures, and my troubling phone call with Callan. This time, the market noticed.

The next morning Lehman’s stock began to fall, and for the next six months, a familiar sequence played out. First came the personal attacks, when Lehman released the following statement to
The Wall Street Journal
:

We will not continue to refute Mr. Einhorn’s allegations and accusations. Mr. Einhorn cherry-picks certain specific items from our quarterly filing and takes them out of context and distorts them to relay a false impression of the firm’s financial condition which suits him because of his short position in our stock. He also makes allegations that have no basis in fact with the same hope of achieving personal gain.

Likewise, the sell-side analysts reacted just as they had with Allied. David Trone from Fox-Pitt, Kelton appeared on CNBC and said I was “looking at data from an inexperienced standpoint . . . the investment banks are very complicated. . . . I don’t think that the ratios he is looking at and the statistics that he is looking at are particularly relevant. I think it is a little flimsy case.” When I confronted him later, he said that someone at his firm had printed out my speech and left it on his chair, but he hadn’t found time to read it before calling it “flimsy” on national television.

The pundits weighed in with their own personal attacks. Outdoing Holman Jenkins, who had called the Allied speech “a mugging” in
The Wall Street Journal
, and Steven Pearlstein, who had labeled me “a punk” in
The Washington Post
, Louise Story wrote on June 4, 2008, in
The New York Times
,

David Einhorn thinks another big Wall Street bank is headed for trouble
—
and he is not being quiet about it. For eight months now, Mr. Einhorn, a rabble-rousing hedge fund manager, has pilloried the venerable Lehman Brothers in an effort to drive down the bank’s stock price, which he is betting against. Lehman Brothers is not amused.

Some paragraphs later, Story continued:

Mr. Einhorn, who runs a $6 billion hedge fund called Greenlight Capital, has been profiting from Lehman’s growing pain. Critics say he is needlessly fanning fears about the precarious health of the financial industry at the very moment executives are struggling to stabilize their ailing companies. Many on Wall Street still wonder if hedge funds like Greenlight helped bring down Bear Stearns and spread false rumors about the bank, a possibility the Securities and Exchange Commission is investigating.

I knew neither which “critics” nor which “many” she was referring to, but I was familiar with the last group. And indeed, just six weeks later, the SEC sent us another subpoena. This time, however, they were satisfied with the information we provided and I was not asked to testify.

A number of people pointed out the problems with Louise Story’s lousy story. Yvette Kantrow in
The Deal
magazine criticized the
Times
for promoting the fight as a battle of the sexes. “Seizing on that, the
Times
ran a particularly ridiculous piece of art with its story, depicting Einhorn and Callan as contenders for the heavyweight title or some similarly ridiculous prize.”

Whitney Tilson commented in a June 13, 2008, piece titled “David Einhorn/Lehman Brothers: Another
NYT
Hatchet Job” in
Seeking Alpha
:

The story here is not David Einhorn vs. Erin Callan or Lehman. It’s whether one of the largest financial institutions in the world—a firm that we now know is de facto backstopped by the U.S. government (and U.S. taxpayers)—is dangerously over-levered and under-reserved, with a great deal of toxic waste on its balance sheet, about which it’s deceiving investors and regulators. Einhorn, a highly respected and successful investor, publicly shared his detailed analysis of Lehman at the Ira Sohn conference last month and then made a transcript of his speech widely available. Many investors obviously think his analysis is correct, so why didn’t Ms. Story’s article explore his arguments, present contrary opinions from the company or elsewhere and really educate its readers on the substantive issues here?

Tilson was pitch-perfect when he wrote, “Einhorn must be feeling a great deal of déjà vu right now.”

The rest of the Lehman Brothers story is history. On June 9, 2008, Lehman Brothers announced a $6 billion capital raise and a $2.8 billion loss. When asked about this by Reuters, I couldn’t help but note, “They’ve raised billions of dollars they said they didn’t need to replace losses they said they didn’t have.”

Three months later, in September, Lehman Brothers filed for bankruptcy, the largest in history, which brought the world financial system to its knees and required trillions of dollars in bailouts for other financial institutions. Although the bankruptcy proved my analysis correct, it was not an inevitable outcome at the time of my speech.

There is an old story about a man caught in a flood. He climbs to his roof as the rain continues. A neighbor comes by in a rowboat and says, “Get in.”

The man replies, “No, the Lord will save me.”

An hour later with the water higher, a rescue helicopter spots the man and offers a ladder. He turns down the help, repeating that the Lord will save him. Eventually, he drowns and goes to heaven.

When God sees the man, he says, “I’m surprised to see you here.”

The man replies, “I thought you would save me.”

God asks, “What did you want me to do? I sent a boat and a helicopter.”

So too with Lehman. It appears that Lehman management observed the Bear Stearns bailout and incorrectly assumed that, if needed, it would be bailed out as well. Accordingly, when presented with several opportunities to save the company, management instead chose to overplay its hand.

In many respects, Lehman’s behavior echoed Allied’s, but on a much larger scale. Both Lehman and Allied responded to financial turmoil by trying to avoid even temporary shareholder pain. They increased dividends, refused to acknowledge impaired investments, and doubled down on risk.

Though Lehman Brothers failed within a year, whereas Allied persisted for most of a decade, that is more a reflection of the economy than anything else. After that fateful Lehman speech in 2008, the markets and the economy sharply deteriorated, leaving Lehman little room to maneuver. In contrast, after my Allied speech in 2002, the economic and capital market recoveries bought Allied years of additional time—time it used to massively expand its business and, ultimately, bilk the taxpayers and its investors out of hundreds of millions of additional dollars.