Fooling Some of the People All of the Time, a Long Short (And Now Complete) Story, Updated With New by David Einhorn (tohfa e dulha read online TXT) 📕

Capital Management and Garrett Van Wagoner. In that case, the SEC found that Van Wagoner misstated the valuations of illiquid, non–publicly traded securities held by its funds. In his case, Van Wagoner undervalued his holdings. In other words, he had been too conservative.

Van Wagoner paid an $800,000 fine, agreed to resign from his position, and agreed not to serve as an officer or director of any mutual fund for seven years. In substance, the SEC put Van Wagoner out of business. No doubt he didn’t have the former head of the Republican National Committee on his board.

Jim Carruthers put it best: “If the SEC had come in 2002 and promptly made these findings and the SBA acted on the fraud when we told them right away, Allied stock would have gone to $3.” Instead, the shares closed at $31.84 the day of the SEC order. I would add that Allied management wouldn’t be in place today and may have served time in jail.

Instead, it took the SEC more than two years after my speech to begin investigating Allied and nearly another three years to complete its inquiry. The findings seemed stale because it took the SEC so long to act. During those five years, the economy nicely recovered from its recession and Allied raised about $1 billion of fresh equity in sixteen offerings (see Table 31.1). This was raised from thousands of retail and institutional investors under pretense that Allied followed the rules and was simply the victim of a “short attack.” These are the investors the SEC is supposed to protect.

Table 31.1 Equity Offerings by Allied Capital since January 2002

So now it was cash-out time: The very afternoon of the SEC order, Allied began the long-delayed “stock ownership initiative” by making a tender offer for 16.7 million vested insider stock options. One would have thought it would have waited a day or two, maybe a week, just to keep from blushing.

CHAPTER 32

A Garden of Weeds

The SEC and other believers took comfort that with third-party valuation assistance, Allied would properly value its investments. I didn’t. As discussed before, Allied did not hire the consultants to perform appraisals. How valuable could these “negative assurances” be coming from third parties that signed-off on the BLX valuation for years? I was certain this fix was form over function: Allied’s underlying ethos was unchanged.

Over the years we have learned that even though Allied’s senior management is dishonest, it did not mean Allied could not and did not make some good investments. There may have been some winners still remaining in the portfolio. However, Allied’s practice of harvesting the winners and keeping its losers had left it with poor prospects. According to Allied’s own valuations, the portfolio had more unrealized depreciation than unrealized appreciation—and that was before taking into full account BLX’s meltdown.

The 10-Q for the second quarter of 2007 included a new disclosure about the BLX investigations. “In addition, the Office of the Inspector General of the U.S. Department of Agriculture is conducting an investigation of BLX’s lending practices under the Business and Industry Loan (B&I) program.” Again, this disclosure appeared as part of a general discussion of BLX rather than under “Legal Proceedings” and Allied indicated it was “ongoing,” misleading the casual reader to believe that the USDA investigation was not a new development. Allied did not disclose when this investigation began and made no mention of it in the earnings release or conference call the prior day.

Later in the 10-Q, Allied warned, “Due to the changes in BLX’s operations, the status of its current financing facilities and the effect of BLX’s current regulatory issues, ongoing investigations and litigation, the Company is in the process of working with BLX with respect to various potential strategic alternatives including, but not limited to, recapitalization, restructuring, joint venture or sale or divestiture of BLX or some or all of its assets. The ultimate resolution of these matters could have a material adverse impact on BLX’s financial condition, and, as a result, our financial results could be negatively affected.”

Moreover, the 10-Q also disclosed that BLX was in default under its credit agreements and had received temporary waivers from its lenders. Even so, Allied advanced BLX another $10 million and BLX drew down on its bank line (the first losses up to half the line were guaranteed by Allied) a further $50 million. The 10-Q explained, “BLX’s agreement with the SBA has reduced BLX’s liquidity due to the working capital required to comply with the agreement.” Allied did not explain why, in light of these troubling facts, it did not take a large, immediate write-down. Instead, Allied wrote BLX down by merely $19 million in the quarter. Inexplicably, Allied continued to value its stake at $220 million, implying an enterprise value in excess of $550 million counting BLX’s borrowings under its credit facility.

In June 2007, Allied announced it raised $125 million for the newly formed Allied Capital Senior Debt Fund, LP, a levered fund Allied managed where it would receive management and incentive fees. Allied committed 25 percent of the capital and raised the balance from outside investors. As part of the fund formation, Allied shifted $183 million of loans off its balance sheet to the new fund. Allied did not disclose which assets it transferred.

One of the assets that disappeared from Allied’s balance sheet that quarter was a $35 million loan to Air Medical Group, an operator of medical helicopters under the name Air Evac Lifeteam. On May 25, 2007, The New York Times reported that the FBI seized documents from its corporate headquarters “as part of an inquiry concerning billing and health care compliance related matters.” This followed a front-page article in the Times from 2005 that reported how Air Evac Lifeteam apparently sent out helicopters and charged insurers in instances that did not appear to be emergencies. Though it was a small investment, Allied increased its unrealized gain in Air Medical Group right after the FBI raided Air Medical Group’s headquarters.

On September