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) 📕

After explaining the oral agreement between Allied and BLX, the article continued: “‘The management of BLX did not want the loans. So they were placed with BLX under an oral agreement that they could be shifted back to Allied if their credit quality deteriorated further,’ she [Sweeney] said.” The original transfer caused BLX to owe Allied the face value of the loans. Ultimately, BLX invoked the oral agreement and transferred the questionable loans back to Allied, which forgave the related debt, according to the article.

This, at least, answered one question I had long had. I had always wondered why Allied paid such a hefty price for BLC Financial. Now I had a new theory: Allied Capital Express held a bunch of improper SBA loans on its books. In 1999, the SBA had conducted an audit and determined that a number of Allied’s SBA loans failed to meet SBA standards. At some point, the SBA would ask Allied to reimburse any losses on those loans. Rather than disclose the bad audit and write-down the loans in 1999, Allied purchased BLC Financial in 2000 (at a high price) and shifted the problem off its books by parking the loans at the newly formed BLX. Apparently, neither company took a write-down for the disqualified loans. Over time, some of the loans performed, while others deteriorated to the point where the SBA demanded a refund. In early 2003, Allied and BLX unwound the parking arrangement for the bad loans and repaid the SBA $5.3 million relating to these loans. This was the repayment the SBA bragged about in our meeting in August 2003.

During the time Allied parked the loans on BLX’s balance sheet, Allied raised almost half a billion dollars of fresh equity. The combination of some of the loans performing, which reduced the potential liability to the SBA, and Allied’s much larger size, meant that the loss was less material to Allied’s financials in 2003 than it would have been if Allied had properly recognized the loss when the initial problem surfaced years earlier.

Sweeney tried to distance Allied from the blame. As she told the Times, “These were loans that were originated by a prior management team, and we had agreed to take them back.” According to Allied’s description of Sweeney’s biographical information in its SEC disclosures in 2000, “Ms. Sweeney also has direct responsibility for the small business lending operations through Allied Capital Express.” Prior management, indeed.

Eichenwald also reported that federal regulators started an informal inquiry into the transaction. Allied issued a press release in response, saying it knew of no such inquiry “into this immaterial transaction that had a negligible effect on Allied Capital’s balance sheet or on BLX’s value.”

Steve Bruce, our public relations adviser, thought Eichenwald’s article was the first shot of his planned exposé. Eichenwald told Bruce that he couldn’t believe the number of hostile e-mails he received from Allied shareholders in response to the article. For a reporter, this is a good sign—he is on to something. He said shareholders were really angry with him for reporting that the SEC would investigate the company. They thought he made it up. Bruce thought the reaction of Allied and its shareholders would inspire Eichenwald to finish the job and report the larger story. We had not told Eichenwald about the SEC’s recent interest or about our pending meeting with the SEC, because we didn’t want to anger the agency. He had his own sources.

On the day the article was published, Brickman and I met with the SEC. It was the first time I met Brickman in person. He was just as he seemed on the phone and via e-mail: irrepressible.

Unlike my previous meeting at the SEC, this one was in a much nicer conference room on the main floor. They had four people there including Kilroy, the “good cop” investigator who had questioned me nearly a year ago. Kilroy indicated she would not be involved going forward, but was there to help the others with the history and to transition the work. The SEC staffers asked us to go through all our current concerns about Allied and BLX. They were engaged, polite and inquisitive. They even brought an accountant with them. The enforcement lawyers asked what kind of documents they should request from Allied and whom should they interview there. Basically, they were asking us to be their cartographers.

Three weeks later, on May 12, 2004, Allied held its annual shareholder meeting. At the end of his prepared remarks, CEO Walton came at the short-sellers once again:

Now I would like to switch gears. I think any people who read the [Washington] Post probably are aware that we have some people in the market who don’t necessarily agree with everything we do. I guess that’s part of being public. It is a phenomenon, which not only affects us but I think many public companies.

But in our case, two years ago we became the target of a misinformation campaign, which we believe was initiated by short-sellers attempting to profit by putting downward pressure on the stock through the use of such misinformation.

In the last several weeks that campaign has once again manifested itself. This seems to be part of a standard playbook used by people who call themselves event-driven investors who distort or, in some cases, simply make up information to manipulate the market. The pattern is pretty clear—take short positions and then do anything in their power to engineer an outcome in their favor. This manipulative activity harms shareholders and ultimately harms the whole capital market.

We’ve watched this activity for the last couple of years. We’ve watched this not only with us, but we believe it has been used with hundreds of companies. There’s a pretty clear pattern to this game. Let me tell you what we see are the ten steps in the short sellers’ playbook. Not quite David Letterman’s Top Ten, but it’s somebody’s top ten.

Anyway, you first identify a