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) 📕

in a sample of the lenders’ loan files. According to the GAO report, the SBA does not adequately measure the financial risk PLP lenders pose to its portfolio. The report indicated that the SBA lacks resources to properly monitor lenders. The office of lender oversight had only twelve staff members overseeing over four hundred preferred lenders, one of them being BLX. There was only one staff member assigned to portfolio analysis and reporting in the entire SBA program.

The GAO report observed that “PLP reviews are not designed to evaluate financial risk, and the agency has been slow to respond to recommendations made for improving its monitoring and management of risk—posing a potential risk to SBA’s portfolio. PLP reviews are designed to determine lender compliance with SBA regulations and guidelines; however, they do not provide adequate assurance that lenders are sufficiently assessing eligibility and creditworthiness of borrowers.”

The SBA reviews lenders through a questionnaire and checklist that generally reviewed the presence or absence of documents in the lender files. Reviewers “are only required to review loan files for completeness and required documentation. Review staff rely on the lender’s attestations rather than independent assessment of loan file documentation.” In short, it’s a check-the-box review without any substance.

“SBA officials said that lender review staff focus on the lender’s process for making credit decisions rather than the lender’s decision. SBA officials said that it is unlikely that the review would result in a determination that the loans should not have been made. An SBA official stated that review staff would not perform an in-depth financial analysis to assess the lender’s credit decision and that a lender’s process would only be questioned in the case of missing documentation. . . . This official said additional training would be required for lender review staff to make more qualitative assessments of loan documentation during the review process.” The report concludes, “Without a more substantive method of evaluating lender performance, this approach does not provide a meaningful assessment.”

Allied touted that BLX routinely received the highest ratings in its PLP audits. Apparently, this equated to good filing technique and the ability to attest to compliance when the poorly trained, government-contracted reviewer came calling. Even if it stumbled onto a problem, the GAO found that the SBA hadn’t even established procedures to suspend or revoke PLP authority. In fact, there were no follow-up procedures for PLP lenders that received poor reviews. Because the SBA wants to encourage lenders to participate in the PLP program, it chose to “work out problems with lenders, and therefore rarely terminate PLP status.”

With this regulatory framework, it wasn’t hard to see how a team of bad guys could bilk the government and taxpayers for big dollars. As Kroll noted, “Senior BLX executives know they can flout SBA rules because there is no effective oversight or regulation of PLP lender practices. In effect, the SBA has no idea of the quality of the loans that BLX is originating, whether BLX is in compliance with SBA rules and regulations or how its loan portfolio is performing.”

After our discouraging meeting with the sleepy-eyed SBA in the morning, we proceeded to the SEC’s headquarters that same afternoon. We met with two SEC enforcement officers, Charles Felker and Walter Kinsey. They walked into the meeting with blank legal pads and let us lay everything out. They took a lot of notes and seemed engaged in the presentation. As we moved from the wrongdoing at BLX to how Allied used BLX to inflate its own financials and made false and misleading statements to confuse the market, Kinsey asked for a written summary. He became frustrated that I didn’t have that information with me, and I promised to provide it in a follow-up package.

That the SEC meeting was better than the SBA meeting was a low hurdle cleared. As with the SBA, the SEC officers didn’t seem interested in obtaining the supplemental list of people with whom to follow up. Indeed, there was no evidence they followed up on anything from our meeting. When I returned to the SEC the following spring (as I will describe in the next chapter), the SEC had an entirely new set of lawyers, who expressed no knowledge of this prior meeting.

To complete the regulatory trifecta, we met Attorney General Eliot Spitzer on August 14, 2003, the day of the Northeast blackout, which shut New York City down shortly after we left. Spitzer took no notes, though he was attentive. He asked good questions, asked for a copy of the Kroll report, and promised to review it and get back to us. We left with some optimism that someone within a governmental office would jump on this. To my surprise, we never heard from Spitzer’s office again.

I sent the SEC a thirty-nine-page follow up letter and supporting analysis in October 2003. The letter covered a litany of our initial accounting criticisms and the change in Allied’s accounting. We included a statistical analysis to test Allied’s contention that it used a consistent valuation method. By comparing the percentage of investments that Allied changed in valuation from one quarter to the next, we were able to show, almost without a doubt, that Allied had indeed changed its portfolio valuation methodology.

For the statistically minded, the data in Table 20.1 showed a 99.9 percent confidence level, a correlation of 0.95, an R-squared of 0.9, and a t-statistic of 8.8. For the non–statistically minded, that is about as certain a conclusion as you can have in statistics.

Table 20.1 Write-ups and Write-downs Recognized Each Quarter

On the July 29, 2003, Allied conference call, notably, Houck, the Wachovia analyst, asked Allied whether the increased number of mark-ups and mark-downs in the most recent five quarters indicated a change in the valuation methodology. “You know, actually I think it’s more related to the economy than anything else. The valuation practice is the same as always,” Sweeney fibbed.

We did another statistical analysis demonstrating that Allied smoothed its investment performance rather than independently valuing each