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) 📕

year to maintain the distribution. As of September 2007 it had about $400 million in the kitty and generated about $110 million in annual net investment income, but had $400 million in unrealized losses in excess of unrealized gains and a large additional loss likely coming at BLX. The kitty appeared under pressure.

If the kitty disappeared, Allied would be left with the option of paying the distributions out of capital as opposed to profits. But Allied’s shareholders might not notice the distinction. Cutting the distribution would be unthinkable. Allied’s focus on easy-to-manipulate taxable earnings accumulated in prior years, rather than current-year reported earnings, should have been a red flag. Paying distributions out of capital, while simultaneously raising fresh capital, fits the classic description of a Ponzi scheme. Is a Ponzi scheme a victimless crime before it collapses?

A Ponzi scheme can exist in what economists call “stable disequilibrium.” Though it is not permanently sustainable, it doesn’t have to fail in any given time frame. Yes, Allied has proven that it can last for years, by chronically selling fresh shares to raise more capital. Such persistence disproves nothing.

CHAPTER 33

A Conviction, a Hearing, and a Dismissal

The Justice Department began to ring up convictions from its Michigan investigation of BLX. In October 2007, Patrick Harrington, the head of BLX’s Detroit office, pled guilty to conspiracy and making a false statement to a grand jury. Noting the investigation was ongoing, Assistant U.S. Attorney Stephen Robinson told Bloomberg, “I anticipate there will be additional indictments.”

Harrington declined to cooperate with the investigation. Bloomberg reported that his attorney said, “The government always wants to go higher, but he never told anyone about it.” As of this writing, Harrington awaited sentencing. More than a dozen other minor participants in BLX-issued fraud loans pled guilty to various crimes.

According to BLX’s statement, Harrington admitted to $6.5 million in fraudulent loans in his plea agreement. BLX vowed, “All losses attributable to Mr. Harrington’s admitted criminal conduct will be borne entirely by BLX.” Notably, BLX did not promise to reimburse all the allegedly fraudulent loans it had originated.

Shortly after Harrington’s guilty plea, the SBA Office of Inspector General posted the findings of its audit of the SBA’s oversight of BLX on its Web site (www.sba.gov/ig/7-28.pdf). Though the audit was completed in July, the OIG held it until October, before posting it with heavy redactions. Page after page, paragraph after paragraph was blacked out; printing the document took a heavy toll on the toner cartridge. Why?

Keith Girard described the SBA’s attempted “cover-up” in a December 2007 “Business Intelligence” column posted on the Web site of The New York Times:

Customarily, the OIG posts such reports on its Website. But when this one was finished over the summer, SBA General Counsel Frank Borchert asked OIG to either withhold or substantially rewrite it. To his credit, Inspector General Eric M. Thorson and OIG’s own attorneys refused. The standoff ended with a compromise. Thorson allowed the General Counsel’s office to edit, or ‘redact,’ the report.

Such requests are not out of the ordinary. Even though the OIG is supposed to be independent, the General Counsel’s office routinely reviews its reports, and sensitive legal, technical, or proprietary information is often redacted. In this case, however, the editing was so extensive, Thorson felt compelled to add a disclaimer on the cover, a first. Nearly all of OIG’s recommendations, for example, were blacked out.

The report compares BLX’s performance to SBA benchmarks for currency rate (the opposite of delinquency rate), loss rate, purchase rate, and liquidation rate, but the actual data were redacted. So were the details in a section titled “On-site Examinations Noted Material Deficiencies and Instances of Noncompliance with SBA Regulations.” Much of the “Results in Brief” section was blacked out, as well the entire “Chronology of Events.” A discussion of the SBA’s internal risk analysis of BLX was redacted, as was a section titled “SBA Continued to Renew BLX’s Delegated Authority and to Purchase Loans.” The OIG described in its disclaimer, “Since 2001, SBA’s oversight activities identified recurring and material issues related to BLX’s performance. Despite these recurring problems, SBA continued to renew BLX’s delegated lender status and SBA took no actions to restrict BLX’s ability to originate loans or to mitigate financial risks through the purchase review process.” Finally, the SBA’s responses to the OIG’s five recommendations were completely redacted, as was a section titled “Additional Comments.”

It was no wonder the SBA used its black marker. Even with the redactions, it was possible to piece together enough of the audit to see that the OIG was extremely critical of the SBA, saying that the agency was too conflicted (loan portfolio growth versus lender oversight) to act against BLX, even though the agency’s inaction was costing the government hundreds of millions of dollars.

The OIG said the SBA did not accept the results of the audit or implement the recommendations. “SBA management was not receptive to the audit findings and recommendations,” the audit said. The first three recommendations were redacted. The others were to develop standard operating procedures to describe when Preferred Lending Program (PLP) status will be suspended or revoked and how it will be done and to address the conflict of having lender oversight reporting to the Office of Capital Access, which focuses on production volume. Whatever the redacted recommendations were, the report said, the purpose was “to mitigate the risk posed by BLX and to promote consistent and uniform enforcement actions.” The SBA plainly did not see eye-to-eye with its own OIG. Even when the OIG saw the problem for what it was, the SBA itself disagreed and didn’t even want public disclosure—let alone debate—about why it disagreed with the OIG.

Reading between the black, one sees that the OIG found enough recurring problems to question whether the SBA should have renewed BLX’s PLP status for the previous six years. Despite abundant red flags, the SBA did not increase its scrutiny of BLX’s loan purchase requests, even as it paid out $272 million of guarantees. The OIG found