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) 📕

Walton wanted everyone to focus on our “motivation.” For Greenlight, Allied is one of many ways for us to make money. It is a part of a large portfolio. However, Allied’s management was quite “motivated” to say whatever they could to get themselves out of this pickle. Certainly, Walton and Sweeney had much more at stake personally than anyone else. For management, Allied is the whole ball of wax. If Allied is shown to be fraudulent, the consequences would be more dire than losing a few dollars. Top management players could lose their jobs and possibly go to jail.

Next, Allied recanted the white paper—acknowledging that SEC accounting rules applied to them after all—and came up with a fresh description of its accounting. Sweeney spoke about the valuation issue and described the white paper (incorrectly) as if she believed most people wouldn’t know what it said:

Now, let’s look at the valuation methodology we use. It is simply beyond dispute that it is both appropriate and consistently applied. Allied Capital developed a white paper, which is posted on our website to describe this valuation methodology. To summarize: Allied Capital’s Board of Directors makes a judgment in good faith to appropriately value the portfolio on a quarterly basis using a valuation policy that has been consistently applied based on the estimated price that a portfolio company could be sold for if a willing buyer and willing seller were to negotiate at arm’s-length. That judgment includes factors recommended by the SEC in accounting series releases that go back thirty years. It includes such factors as the company’s current and projected financial condition, cash flow and profitability, net liquidation value of tangible business assets, yield to maturity with respect to debt issues, debt to equity ratios and so forth.

While this comment is interesting, it is not accurate. In fact, the Allied white paper stated the opposite. As discussed in Chapter 8, the whole point of the paper was to rationalize not using the SEC accounting series releases. Clearly, Allied had received some advice (the advice probably came from the SEC, though it is possible Allied hadn’t yet heard from the SEC and simply realized its own mistake) that its white paper, with its brazen view that SEC valuation guidance did not apply to them, was wrong. Allied now ran away from its white paper as fast as it could. Allied changed its tune and would no longer claim that SEC policies don’t apply or that measuring the value between a willing buyer and seller at arm’s length was difficult or impossible to apply to its investments.

Sweeney continued her script with what she called “FACTS” or, better yet, “INDISPUTABLE FACTS.” This type of wordplay was typical of Allied’s approach. Apparently, Sweeney felt that if she said the word FACT loudly enough, with enough emphasis, many people would accept what she said as true.

She then tried to defend Allied’s accounting policies. “Regarding the question of propriety of our methodology,” she said, “here are a few indisputable facts. FACT: The valuation methodology outlined in our white paper is nearer in our form and to [the] shelf registration statement, which is filed every quarter with the SEC, and the SEC has consistently found these filings satisfactory.” Of course, Allied had only introduced this language in its SEC filings earlier that year, giving the SEC little time to opine on it.

Further, Sweeney said that Allied’s statement of accounting policies matched the white paper and was Allied’s actual practice. Allied’s current annual report echoed the white paper, stating, “The Company will record unrealized depreciation on investments when it believes that an asset has been impaired and full collection for the loan or realization of an equity security is doubtful.”

However, starting with this conference call, Allied switched its descriptive language from an impairment test to current-sale valuation based on where willing buyers and sellers would transact. Without fanfare, in its next SEC filing, Allied eliminated the offending language that had described its valuation methodology in terminology consistent with its discredited and withdrawn white paper. Eventually, Allied would say the white paper was a “discussion piece for an industry conference” and claim that it never actually used that type of accounting.

Sweeney continued, “FACT: Mark-to-market and fair-value are not the same thing. It has been falsely stated that the appropriate valuation method to be used is a rigid mark to market or fire-sale.” Presumably, she meant it was falsely stated by short-sellers, though I don’t know who.

Of course, this was more wordplay. We argued that fair-value accounting required a mark-to-market approach. She simply added the part about fire-sale. This was a convenient invention because the SEC said fair-value accounting should not require a fire-sale valuation. Having now falsely tarred us as claiming that Allied needed to use fire-sale values, she had no trouble explaining that we were wrong. She continued, “The experts do not agree, and for good reason. Fair-value is a regulatory concept that includes the concept of current sale, which is not the same thing as fire sale. The term is defined by the AICPA guide as a current sale means ‘an orderly disposition over a reasonable period of time between willing parties other than a forced or liquidation sale.’”

A few minutes later in the call, in response to a question about whether Allied complied with the Investment Act of 1940, Sweeney again rejected the white paper and adopted the current-sale test: “We apply a current-sale standard, and how we do that is every quarter we actually determine the value of the portfolio company if it were to be sold today in a current-sale. In other words, what in an arm’s-length transaction would a willing buyer pay for a company? . . . If the enterprise value of the company is in excess of our last dollar of capital, we have no need to depreciate a debt security and, in fact, we may have evidence of appreciation for an equity security.”

This was