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) 📕

to the SEC on September 3, 2002, where I pointed out the manipulative aspects of the rights offering. I don’t know if my letter had any effect. However, Allied amended the deal to eliminate the requirement for shareholders to hold the shares continuously between the record date and the exercise date. Allied set the pricing at a 7 percent discount to the market price on the date the rights expired. Investors did not have to hold the shares for an extended period to maintain the rights and would not be subject to the uncertainty of exercising the rights at an unknown value. Allied gave shareholders the right to purchase one additional share for every twenty shares they held. Allied also gave shareholders “oversubscription” rights, or the opportunity to subscribe for additional shares in the rights offering for any shares that other rights holders did not purchase.

The final prospectus no longer said that the purpose was to “reward the long-term shareholder.” Instead, it said, “Our board of directors has determined that this rights offering is in our best interest and in the best interests of our shareholders. The offering seeks to reward the long-term shareholder by giving existing shareholders the right to purchase additional shares at a price below market without incurring any commission or charge. . . . Our board of directors makes no recommendation to you about whether you should exercise any rights.”Buyer beware.

If the purpose were to reward long-term shareholders, it was a reward that the management and directors, for the most part, decided to forgo. According to the proxy, nineteen insiders were granted rights to purchase 123,000 shares, in addition to oversubscription rights. As a group, they exercised about one-third of their rights. Collectively, this was less than they receive in a single quarterly tax distribution check.

Speaking of insider purchases, Allied management made several small insider purchases between my speech on May 15, 2002, and the end of the year. As one Allied shareholder asked me, “Allied insiders have been buying shares and not selling. In fact, I think the last insider sell was more than a year ago. This does not seem like the behavior of management that is hiding something. If, as you suggest, they are privy to negative information that likely would be detrimental to the stock price, it’s inexplicable to me why they would put more of their own money at risk.”

This, of course, is a straightforward and logical analysis. I agree that insider purchases are generally bullish. However, in this case, the insider purchases were so small relative to the financial wherewithal of the participants and to their existing stakes in the company that they appeared to be simply an effort to “signal the market” with news of insider purchases, thus reassuring retail investors like this fellow. In context, this was not a serious effort to increase their stakes by taking advantage of discounted prices.

Walton earned $2.4 million in cash compensation for running Allied in 2001 and held about $10 million in stock, with options to purchase many more shares. For him to invest about $46,000 to purchase an additional 2,000 shares is hardly an increased commitment. (Walton did this shortly after my speech. In the rights offering he exercised rights to purchase approximately 11,000 shares, effectively reinvesting a single quarterly distribution back into the stock.) Considering his vested interest in the outcome, $46,000 is an awfully cheap form of “advertising” his “confidence.”

If insider purchases are indiscriminately believed to be a bullish indicator, bad actors can use them as false indicators at desperate times. Dennis Kozlowski and Mark Swartz of Tyco each spent about $15 million to signal the market with insider purchases in January 2002. In June 2005, Kozlowski and Swartz were found guilty on twenty-two of twenty-three counts of grand larceny and conspiracy, falsifying business records and violating business law. They were ordered to pay fines and restitution of over $200 million and given lengthy prison sentences.

In August 2002, Professor André Perold, who teaches an investment course at Harvard Business School, called to ask if I would meet with his class. He had heard about Greenlight’s work on Allied and wanted to teach the story. I checked into Perold’s reputation. It was excellent, so I agreed.

I met with his class in October, and Perold discussed Greenlight’s Allied analysis with his students. I took fifteen minutes of questions at the end. Perold’s lecture seemed supportive of our thinking. The student reaction was mixed. The class materials included the analysis we posted on our Web site, which had a discussion analogizing Allied’s relationship with BLX to Enron’s relationship with its Raptor partnership. One student thought the comparison was unfair. Others nodded in agreement.

I explained that we said that the relationships were analogous in that both were controlled, unconsolidated entities that contributed to the parents’ earnings without any transparency in the underlying results. In both cases, the parent company guaranteed the financing. In Raptor’s case this came from a pledge of Enron stock, and in BLX’s case from equity investments and debt guarantees. No one in the class seemed inclined to argue. Perold said he wanted to write a case study and would invite Allied to tell its side.

While I was in Boston, I learned that Deutsche Bank initiated research coverage of Allied with a “Sell” rating. This was surprising. Analysts rarely urge investors to sell. If they don’t like a stock, they usually mute their language, telling investors not to buy more and rate the stock “Hold.” A “Sell” rating often angers the company, its institutional investors and creates problems for the analyst.

In an extraordinary move, the New York Stock Exchange, normally a slow-moving organization, decided to immediately investigate the “Sell” recommendation and hauled in Mark Alpert, the analyst who issued the recommendation, and the Deutsche Bank institutional salesman who covered Greenlight. The salesman had sat with me at the Allied investor day, and Allied, always looking for a good conspiracy, cried foul. The Exchange questioned the salesman and the