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) 📕

complained. It impressed me that the SEC was following up the very same day. The questions they asked implied a concern that I created a phony issue to scare other participants on the call, rather than get an answer from the company. I explained what I knew of Carruthers’ work and the subsequent follow-up calls from Hohimer to the former BLX employee and to me. The SEC lawyers seemed satisfied that I wasn’t making this stuff up.

In early March 2003, we received a subpoena from Attorney General Spitzer’s office dated February 28, 2003. I was requested to appear on April 15 “to testify in connection with the offer and sale of securities including, but not limited to, false statements, fraud, and efforts to manipulate the market.” We were to provide an even more exhaustive list of material, including records relating to several companies on which Gotham published research, a list of all of our investors, communications with several other hedge fund managers, and communications with several journalists, including my wife.

On March 25, we received a subpoena from the SEC. The case had been recaptioned In the Matter of Gotham Partners Management Co., L.L.C. The attachment showed that on February 11 the SEC upgraded it to a “formal investigation.” This gave it subpoena power. I was asked to appear in Washington, D.C., on April 15 and 16. The investigation sought to determine whether Gotham and other hedge funds used false or misleading statements or engaged in manipulative trading to depress these stocks. The investigation related to Farmer Mac, MBIA, Allied Capital, and American Capital Strategies. American Capital Strategies was one of Allied’s competitors, which we had not shorted or criticized. In fact, we owned it in 1998–1999. It had the same business model as Allied, so some believed that our criticisms applied to it as well. In fact, most of our critique had nothing to do with the business model. I don’t believe there is anything inherently wrong with business development companies. Greenlight’s criticisms are specific to Allied Capital, its accounting and corporate behavior.

On April 4, the SEC sent a subpoena for documents to be produced by April 11. Was it a coincidence that these notices kept arriving on Friday afternoons? Now they wanted information on other companies, information on trading credit derivatives (we don’t trade these), our client list, client redemption requests, and our correspondence with several other hedge funds. As we turned over documents and prepared to meet the government, I was not at all worried that we were in trouble or had done anything wrong. But I found it irritating to have to hire lawyers to sift through e-mails and was frustrated that the government was investigating the wrong party. It seemed as though they were looking through the wrong end of the binoculars at the wrong (very small) person—me. I hoped that when we met, I could convince them to retrain their sights on Allied.

A couple of weeks later, a federal judge in New York dismissed the class-action suit against Allied over its accounting that had been filed shortly after my speech. The judge ruled:

Since Allied’s accounting policies were publicly disclosed in some detail in each of its SEC filings, the basis of plaintiffs’ theory of fraud must be either that the stated policies led to hidden overvaluations of specific investments, or that Allied did not adhere to its publicly stated policies. Because plaintiffs have not alleged sufficient facts to either theory, they have failed to plead that defendants made fraudulent or misleading statements.

First, plaintiffs have not sufficiently pled that Allied’s valuation policies resulted in its overvaluing some of its investments. The complaint simply states plaintiffs’ opinion that various valuations were inappropriate, and sometimes a brief reason for that opinion, but fails to allege what plaintiffs contend was the true valuation.

A few pages later, the ruling continued:

Even if plaintiffs had pleaded sufficient facts to support an inference that Allied may have overvalued some of its investments, plaintiffs have not alleged the extent of any such overvaluation. In order to plead fraud with particularity, plaintiffs must state by how much Allied overvalued the investments. . . .

Because plaintiffs have not alleged the amounts by which Allied allegedly overvalued the questioned investments, plaintiffs have not pleaded any facts that would permit a rational jury to conclude that a reasonable investor would have viewed the overvaluation as significant.

In other words, it was up to the plaintiffs to show the judge what the true valuations were. This was a Catch-22, because the lawsuit was dismissed prior to discovery. Since most of Allied’s investments were to private companies, where only Allied held the confidential information required to ascertain a precise valuation, plaintiffs were in a tough spot to show the true valuations without access to the information.

The judge was not worried by this, because he came to the questionable conclusion that “Allied’s actual valuation policies were public, as was all adverse information about the companies in which Allied had invested. . . .” Where did the judge think Allied disclosed all this adverse information?

The judge found:

. . . Even when plaintiffs provide a reason that an investment’s value should have been reduced, such as the company’s bankruptcy, they do not explain why that factor should have been accorded significance or allege that Allied’s policy did not take that factor into account. Therefore, the complaint establishes nothing more than that the plaintiffs disagree with some of Allied’s investment valuations—but given the difficulty of valuing illiquid securities, and the multitude of factors that may appropriately be taken into account, alleging disagreement with some of Allied’s valuations does not equate to alleging fraud. . . .

Because the case was thrown out before the plaintiffs were able to take discovery, the plaintiffs were never able to take testimony, see Allied’s books and records, or see how Allied justified its valuations. In other words, the case was dismissed before the plaintiffs could get their hands on the Allied documents that would have shown