Fooling Some of the People All of the Time, a Long Short (And Now Complete) Story, Updated With New Epilogue (22 page)

“And what were your discussions with Mr. Gladstone at that time?” Kilroy asked.

“We asked him about things that were on our mind and what his opinion of those things were,” I replied.

“What sorts of things were on your mind at that time?”

“We were concerned with some of the valuation processes, some of the individual valuations that Allied was doing, some of the what we would call the intercompany relationships and so forth, and I think we posed a variety of questions to David Gladstone.”

That obviously wasn’t enough for Kilroy, and she kept coming back to Gladstone. Even though my answers were always the same, she asked me repeated questions about him throughout the session, fishing for something that just wasn’t there.

“How did you meet Mr. Gladstone? Did you remain in contact with Mr. Gladstone since the time that you met him, or did you come back into contact with him when you started looking at Allied? How did you start speaking with him about Allied? What was the substance of your dialogue? Did he assist you with your research or serve as a sounding board? What was the nature of your discussions?”

I believe the SEC was focusing on Gladstone because Allied had advanced a conspiracy theory that I was a shill for Gladstone and our true purpose in criticizing Allied was to advance the prospects for Greenlight’s minimal holding in Gladstone Capital, which we sold in the second quarter of 2002.

Allied seemed so concerned about Gladstone that after
Forbes
ran an article where Walton called me a “predator,” Allied approached the author with a juicier story. On September 2, 2002,
Forbes
published “Hit Man,” which said Gladstone had been fired from Allied for hitting a female employee and suggested that a vengeful Gladstone had been badmouthing Allied’s accounting. I believe Allied did this as part of its campaign to attack the messenger when they couldn’t attack the message and to gain sympathy as a victim of another imagined conspiracy.

During my SEC testimony, the lawyers also asked repeated questions about my speech and why I had issued a written report a month later.

I answered, “Allied had several conference calls and several press releases and was saying various things to the media and so forth. And I felt that a lot of what they were saying was untrue. I felt a lot of what they were saying was misleading. I felt that some of what they were saying was defamatory, and I felt that they were misstating what we had said. I felt that they were mischaracterizing our analysis, and they were accusing us of a whisper campaign. And I felt it was important to set the record straight and to say what we thought the facts were and see if we could put some real facts out there to clarify things.”

Periodically, Kilroy asked softball questions, possibly because she may have seen merit in Greenlight’s criticisms, which allowed me to defend myself easily and even turn the question back toward Allied. For example, “Were you more often than not able to ask questions on [Allied’s conference] calls or did you get a sense that you were being screened out of their calls?”

Near the end of the first day of testimony, Kilroy asked me a question, the answer to which had become obvious: “At the time that you made the speech, did you anticipate that your position on Allied would become so public, or was it your thought that you would give this speech, say what you thought about the company, and then that would sort of be it, and what would happen to the stock would happen to the stock?”

“If what you’re asking is did I feel that the reaction was much, much greater than I would have anticipated? The answer is
yes
.”

CHAPTER 18

A Spinner, a Scribe, and a Scholar

On the morning of my second day of testimony,
USA Today
ran a feature on Lanny Davis, headlined, “Crisis Lawyer Tackles New Target: Hedge Funds.” According to the article, Davis had put together a crisis management team to represent companies that were embroiled in scandal. Davis indicated that he had worked for several dozen firms since 1999 and only a couple of times had his name surfaced as part of his work. The article told how Davis took HealthSouth CEO Richard Scrushy “on a tour of corporate governance experts” to help the company form “an ethics oversight board.” Scrushy left HealthSouth and was acquitted of the securities fraud charges in 2005. In 2006, he was convicted of bribery, conspiracy, and mail fraud and sentenced to almost seven years in prison in 2007. According to the article, Davis “broke off his relationship with HealthSouth.” The article explained:

Davis goes on and off the record with such frequency that a newcomer to the game can easily suffer spin vertigo. [Now, Davis was] busy assembling the Full Disclosure Coalition, a group of corporate clients who are pressing Congress to enact legislation that would require investors who sell stocks short (making bets that they will fall) to meet the same disclosure rules as [long investors].

I believe the point of asking short-sellers to disclose who they are is to intimidate them. As I had seen, Allied made great effort to refer to Greenlight’s criticisms as “the short attack” and to undercut our credibility by harping on Greenlight’s financial motive. Allied personified me as the villain to appeal to investors to make a choice: Either they were with Allied or they were with the manipulator. That way investors didn’t need to pay attention to the substance of what we said or critically judge the adequacy of Allied’s responses.

The
USA Today
article continued by describing Allied’s “campaign” against me:

“Allied Capital has launched a very unusual and very aggressive shoot-the-messenger campaign,” Einhorn says. “I suspect it’s because they don’t have adequate answers to serious questions about their business and accounting.”

Davis shoots back: “Allied has answered every assertion Einhorn’s made. Einhorn has a record of using innuendo as a surrogate for facts.”

Now, Lanny Davis wanted the ability to launch similar campaigns against others. As Jim Chanos, a prominent short-seller, observed, the sponsors of the Full Disclosure Coalition have insisted on
anonymity
—an Orwellian twist too rich for fiction. Allied may or may not have been its largest financial backer. However, aside from the
USA Today
article, I never saw another public reference to the Full Disclosure Coalition. A recent Google search for “Full Disclosure Coalition” only showed twelve results, including the
USA Today
article and a couple of short-sellers commenting on the story.

To my relief, my second day of SEC testimony was less stressful than the first. We went through the parts of Greenlight’s published report where Allied disagreed. I almost enjoyed getting to explain why the PIK income forced Allied to raise capital to support its tax distribution; how I determined Allied mismarked 35 percent of its investments; why Allied’s ability to exit certain investments at their carrying value didn’t prove Allied valued the portfolio properly; how Allied changed its business model and accounting; why Allied’s relation to BLX was analogous to Enron’s relation to its Raptor partnership; why Allied had no reasonable basis for its valuation of BLX; and how Allied designed the rights offering to manipulate the market. These were all easy topics for me. They asked some more questions about Gotham and our short sales of Farmer Mac and MBIA. Finally, they asked about Todd Wichmann of Redox Brands, who had told us of Allied’s bad behavior with his company.

At the end of the day, they asked me if I wanted to add anything to the record. At the time, the SEC was considering regulating hedge funds in an effort to curtail fraud. I said that I couldn’t see how hedge fund regulation could be effective when the SEC allowed an already regulated investment company, Allied, to complete additional public offerings prior to the SEC fully investigating and resolving the issues we brought to its attention.

We were done. We even finished before lunch. I left feeling like I had just gotten out of class on the last day of school. I went back to New York and waited for the fallout and my turn with Spitzer. His office set up dates for interviews twice, but canceled both times. Since then, we’ve heard from neither the SEC nor the New York attorney general’s office about investigating us.

We did hear again from David Armstrong, one of
The Wall Street Journal
reporters who had written the article about regulators investigating Greenlight. He said he wanted to write the Allied/Greenlight story, I suspected at Allied’s suggestion. So James Lin and I sat down with him. Armstrong had already met with Allied and came armed with questions. Like the SEC lawyers, Armstrong asked questions on topics that were upsetting Allied, and James and I answered them all. We watched the video of the charity speech together. Armstrong remarked that it didn’t seem like a big deal. When we were through, I thought Armstrong believed we had the stronger argument and raised some good points about Allied’s valuations and accounting practices. He seemed to leave with an understanding of our criticisms of Allied.

The
Journal
soon published a multipart series on hedge funds. The series graphically depicted hedge funds with a pair of fuzzy dice. The series didn’t contain a positive word about anyone in the field. I suspect Armstrong targeted his work with us to fit into that anti–hedge fund series, but
couldn’t
because the facts were on our side. I believe this ran contrary to his purpose and personal bias in working on the subject. Rather than writing a story that supported our view, he wrote none at all.

We next heard from Professor Perold from Harvard Business School, who completed his case study of Allied. I was surprised because he hadn’t contacted us since I spoke to his class in October 2002. Though he had not yet shown it to us, he’d given the case study to his students and already taught from it. The case study was also “in the market,” because a mutual fund called to inquire about it.

The study read like Lanny Davis wrote it. I was dumbfounded. Why would a professor at the Harvard Business School, who seemed like an intelligent guy, write a case study that resolved everything in Allied’s favor? The study was full of errors and told only Allied’s side of the story. The study described many of our arguments as false and having been “refuted.” It misunderstood Allied’s accounting, how the company treated BLX on its books, and implied that the company’s critics were involved in a conspiracy against it. The case study accepted Allied’s contention that it did not change its accounting in 2002 and had been consistent all along. The study even repeated Allied’s claim that we barely spoke to management before I made the speech.

I worried that this study could become the “history” of the event from Allied’s point of view, but with Harvard’s name on it! Perold completed the report on July 3, 2003, and sent us a PDF version by e-mail. We asked if he would send us a version in Word so we could intersperse comments into the text of the document. He refused, so I had to have an assistant retype the whole case study so we could note the errors to send Perold. James Lin and I followed up with a phone call to walk through our comments, point out errors, and express our concerns.

Perold promised to make things right, and we spoke for more than two hours as we went over the study point by point, telling him about the mismarkings, Allied’s lies, and the problems at BLX. It was a long, exhausting phone call.

“I warned you this was going to take some time,” I told him when we were about halfway through.

Perold expressed his willingness to continue the discussion and his enjoyment trying to sort out the contradictory claims.

I told him that I also had a problem with the study’s habit of calling this a short attack, which is Allied’s often-used terminology.

“We think this is inflammatory,” I said.

“Oh, go on,” he said, amused. “What the hell else is it?”

“It’s not an attack. We raised issues. We shared our research.”

Perold laughed. “Oh, God,” he said, sounding exasperated. “You didn’t sell the shares hoping the stock would go up.”

“That’s not an attack, that’s an investment,” I said.

He agreed to change it.

By the end of the call he agreed to take my points to Allied for its response. I asked if he would offer the similar courtesy to show us Allied’s response so we could comment on it before he published again. He declined. He indicated that it was customary in Harvard case studies to give the subject company involved a chance to comment. I pointed out there were two subject companies—them and us. It made no difference—this was a one-way street. Perold would offer only Allied the opportunity to comment in advance.

Yet, a larger problem still remained: that Perold had already distributed the first draft of the case study. I asked Perold if he could reclaim the erroneous copies from his students. Perold said he would try his best and would tell everyone that the study in its current form was just a draft, a work-in-progress. That process repeated itself a few months later when Perold released another faulty version of the case study to his students prior to soliciting Greenlight’s comments. We pointed out the errors and complained about the process. In each version, he incorporated many of our changes, while ignoring others.

I was still mystified as to why this process was so difficult. Then, out of the blue, one of Perold’s students informed me that Perold’s research assistant on the case study worked at the investment firm Capital Research and Management (CRM) the previous summer.
CRM was Allied’s largest shareholder
. After graduation, the research assistant rejoined CRM. I asked Perold to disclose the conflict or even the appearance of conflict in the report. He refused. When I pressed him, he could offer no other reason than it was his case study. The final version came out in early 2004 and was fairer.