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) 📕

million they disclosed earlier in the year) and held its valuation of BLX constant. On the conference call that day, Walton continued to insist that BLX’s “core business is profitable.”

Management was asked about the narrow gap between the value of the investments it exits and the most recent prior valuation on Allied’s books. Walton noted, “I think a lot of this has to depend on the timing of when we actually realize the gain versus how close it is to the end of the quarter. What happens is if you get—sometimes we have taken the gains just hard on the heels of a quarter where we know exactly what the gain’s going to be and we mark it up. One of the things that would be interesting, we haven’t done this yet, is to look back a couple of quarters to see where we were two quarters prior to exit. . . .”

Sweeney added, “When you have perfect knowledge, it’s really easy to get the valuation exactly right.”

I couldn’t have said it better myself. That had been our point back in the debate of 2002! The accuracy of the most recent marks prior to exit reflects exactly the status of the exit process and provides no comfort that Allied properly values the rest of the portfolio.

CHAPTER 31

The SEC Finds a Spot under the Rug

On June 20, 2007, came the moment we’d all been waiting for: The SEC released the results of the investigation of Allied it had announced in 2004. The agency released an “Order Instituting Cease-and-Desist Proceedings, Making Findings, and Imposing a Cease-and-Desist Order Pursuant to Section 21C of the Securities Exchange Act of 1934” in the matter of Allied Capital Corporation.

The six-page order found:

From the quarter ended June 30, 2001 through the quarter ended March 31, 2003 Allied violated recordkeeping and internal controls provisions of the federal securities laws relating to the valuation of certain securities in its private finance portfolio for which market quotations were not readily available. During the relevant period, Allied failed to make and keep books, records, and accounts which, in reasonable detail supported or accurately and fairly reflected certain valuations it recorded on a quarterly basis for some of its securities. In addition, Allied’s internal controls failed to provide reasonable assurances that Allied would value these securities in accordance with generally accepted accounting principles. Further, from the quarter ended June 30, 2001 through the quarter ended March 31, 2002, Allied failed to provide reasonable assurances that the recorded accountability for certain securities in its private finance portfolio was compared with existing fair value of those same securities at reasonable intervals by failing to: (a) provide its board of directors (“Board”) with sufficient contemporaneous valuation documentation during Allied’s March and September quarterly valuation processes; and (b) maintain in reasonable detail, written documentation to support some of its valuations of certain portfolio companies that had gone into bankruptcy.

The order continued:

With respect to 15 private finance investments reviewed by staff, Allied could not produce sufficient contemporaneous documentation to support, or which accurately and fairly reflected, its Board’s determination of fair value. Instead, in some instances, the written valuation documentation Allied presented to its Board for these investments failed to include certain relevant indications of value available to it (as further discussed below) and sometimes introduced changes to key inputs used to calculate fair value from quarter to quarter without sufficient written explanation of the rationale for the changes (e.g ., changes from EBITDA to revenue-based valuations and in some instances, changes in the multiples used to derive enterprise value). The written valuation documentation does not reflect reasonable detail to support the private finance investment valuations recorded by Allied in its periodic filings during the relevant period.

The order proceeded to give three examples labeled “Company A,” “Company B,” and “Company C,” which we can identify as Startec, Executive Greetings, and Allied Office Products, respectively.

Company A—During the relevant period, Allied held a debt investment in Company A, a telecommunications company. Allied was unable to produce contemporaneous written documentation, in reasonable detail, to support its valuation of Company A during the quarters ended June 30, 2001 and September 30, 2001. Specifically, Allied’s valuation of Company A for these quarters was derived, in part, by including revenues from discontinued lines of business to establish fair value. Allied maintains that it used a reduced multiple to offset any potential overstatement that would have otherwise resulted from the inclusion for those revenues, but it did not provide the Board with contemporaneous written documentation, in reasonable detail, to support this claim. In addition, Allied did not retain the valuation documentation it presented to the Board for Company A for the quarters ended December 31, 2001 and March 31, 2002. Allied valued its $20 million subordinated debt investment in Company A at $20 million (i.e., cost) in its Forms 10-Q for the quarters ended June 30, 2001 and September 30, 2001. In its 2001 Form 10-K and its form 10-Q for the period ended March 31, 2002, Allied valued its subordinated debt investment in Company A at $10.3 million. Allied subsequently wrote down its subordinated debt investment in Company A to $245,000 in its Form 10-Q for the quarter ended June 30, 2002.

Company B—During the relevant period, Allied held a subordinated-debt investment in Company B, a direct marketing company. Allied was unable to produce contemporaneous documentation, in reasonable detail, to support the basis for its valuation of Company B for the quarter ended March 31, 2003. Specifically, Allied’s valuation was based, in large part, on a potential future buyout event by Allied that was preliminary in nature. Allied maintains that—as a general practice—the Board would have discussed why this particular potential future buyout event was significant enough to form the basis of its valuation of Company B, but it could not provide contemporaneous written documentation in reasonable detail to support this claim. Further, Allied’s valuation documentation did not fully reflect Allied’s consideration of competing buyout offers for Company B, which, if accepted, would