Fooling Some of the People All of the Time, a Long Short (And Now Complete) Story, Updated With New Epilogue (3 page)

Introduction to This Edition

T
he publication of the hardcover edition of
Fooling Some of the People All of the Time
occurred even as the story was still developing. In the two years since, this “Long Short Story” is now also largely complete. Rather than modify the original material to adjust for subsequent developments, I have chosen to leave it in its original form, except for correcting a few typographical errors. Instead, I have added an “Epilogue” section, which is really the completion of the story. For readers of the hardcover edition who want to read the end of the story, it makes sense to jump straight to the Epilogue.

David Einhorn

September 2010

INTRODUCTION

The Spark of a Speech

My father, Stephen, wanted to write a book before he turned forty, and at thirty-eight realized he better get started. Since he wasn’t yet ready to delve into a serious issue or share a grand vision of the future, he wrote a joke book.

On his fortieth birthday, our entire extended family from around the country joined us in Milwaukee to celebrate. The party was held at a Chinese restaurant. Each member of the family had to give a “review” of the book. The catch: The books weren’t to be handed out until the end of the night.

I remember Grandpa Ben getting up with his notes. As he stood there, he allowed the paper to unwind like a roll of toilet paper until it extended to the floor. He proceeded to review the book. “On page 11 it says . . .” and he told a funny story. “On page 49 the joke goes . . .” and he told a funnier story. “On page 361 Steve wrote . . .” and we were falling off our seats. “On page 12,329 the joke begins . . .”

That evening is one of my best childhood memories.

After the party, Dad gave me the very first copy of his book
If You Try to Please Everyone, You Will Lose Your A**
. . .
and 89 Other Philosophical Thoughts
. My parents sold about a thousand copies. I think there are probably a few hundred left in the basement. Dad has updated it for his sixty-fifth birthday in June 2008.

Though I had no intention of writing a book by the time I turned forty, extraordinary circumstances have caused me to beat the deadline. I wish it were a joke book. It’s not.

This is the story of a dishonest company called Allied Capital. If you play with the name it isn’t hard to conjure ALL LIED CAPITAL. Think of it as
The Firm
in John Grisham’s book without the sexual tension and chase scenes. This is a company that is not only fooling its shareholders by paying lofty “dividends” partly based on new capital contributions in a classic pyramid scheme format, but is also robbing taxpayers.

I may be a “whistle-blower,” but I’m no Erin Brockovich. I am one of the luckiest people in the world. I have terrific parents who raised me well. I have a smart and wonderful wife and three good-spirited, healthy children. I have had success in business that I never dreamed I could achieve. I work with intelligent, good people. To me, it isn’t even really work. Compared to hard work like manual labor or dealing with a difficult boss, my work is fun.

Not many people have heard of Allied. I have been asked repeatedly: “Who cares about Allied Capital? What are you trying to accomplish? Who is the audience?”

There are a few possible audiences for this book. The first is members of the Greenlight Capital “family.” Greenlight is the investment company I run. Our core products are commonly known as hedge funds. I believe we have an excellent reputation—not just for good results, but for thorough analysis and integrity. We are a firm that is not shy about self-criticism when we make mistakes, and we make plenty.

For those of you who are part of the Greenlight family, I am happy you are reading this story, but you are not the target audience. As you may already know, Greenlight has held a “short” position in Allied Capital for six years; that is, we have allocated a portion of the fund to profit if Allied’s stock declines in value. Most of you have heard me describe Allied’s misconduct for years. As a result, you may already agree with me and share my frustration.

A second possible audience is the tens of thousands of holders of Allied stock. If you have invested in this business development company (BDC), you have done consistently well for up to forty-five years. As a large group of mostly individual investors, you appear not to care about what I have to say. Judging by some of the nasty e-mails I have received, some of you vociferously resent Greenlight’s efforts. You do care about Allied’s quarterly cash distributions. As long as they keep coming, most of you are in for the ride. Many of you will probably think this book is a desperate attempt to persuade you to dump your Allied stock so Greenlight can make money as the stock falls. Management has repeatedly said I am on a “campaign of misinformation for personal profit.” You probably believe them. If so, nothing I write will change your view.

What you may not understand is that in the scheme of things, Greenlight’s bet against Allied Capital is not that significant. While there may be a lot of dollars at stake, Allied is not our largest or most important investment. Over the last six years, our firm has had 3 percent to 8 percent of its capital invested in selling short Allied.

Also, in 2002 Greenlight’s principals pledged to donate half of anything we personally made on Allied to a pediatric cancer hospital. When the investment didn’t pan out as quickly as we hoped, Greenlight donated $1 million to the hospital in 2005. As I said at the time, “I have been waiting, but the children should not have to wait.” With the publication of this book, we are now pledging to give the other half of our potential personal profit (including our share of book royalties), to two worthy organizations: the Center for Public Integrity and the Project On Government Oversight, both in Washington, D.C. This book shows, if nothing else, that we need better investigative journalism and government watch-dogs. This should make clear that my interest in the story now extends well beyond money, because no matter how far Allied’s stock price eventually falls, I personally don’t stand to make a dime. Nonetheless, Allied shareholders are not the target audience for this book, either. Frankly, I’m surprised if many of you have read this far.

Of course, Allied management doesn’t want you to read this book, either. In fact, they don’t want anyone to read this book. They have had their lawyers send at least five letters to the publisher to discourage this book’s publication. They have offered to make Allied’s senior management available to the publisher to make sure the book is “accurate, responsible and fair.” The publisher advised Allied that it would be more appropriate to have management direct its concerns to the author of the book, and I offered to meet with them to give management that opportunity and to ask some questions of my own. Of course, this same management, which has refused opportunities to meet with us for years, declined again. In fact, as I will describe later, Allied management has a standing policy of avoiding meeting with
any
hedge funds. Allied’s lawyers say, “There may well be a book that a long-short hedge fund manager like Mr. Einhorn should write that tells the story of how the ‘shorts do well’ by ‘doing good,’ i.e., how they make millions while also helping the SEC and other regulators.” They just don’t think Allied is the right example. I think readers of this book will be the judge of that.

My desired audience is much broader than these small groups. I hope this book is ideal for those who know something about investing and care about the stock market, business, ethics, and government itself, which is supposed to keep the playing field flat and fair. As you read this book, at some point you will say to yourself, “Enough! Enough! I get it, already! This is a bad company! You’ve made your point!”

But have I? The reason for writing this story is to document via a “case study” the wrongdoing of Allied Capital, and as important, to unveil the indifferent attitude of regulators—our government representatives—toward that wrongdoing.

As you read, you may ask the same questions I ask myself: Where are the regulators? Where is the Securities and Exchange Commission (SEC)? Who works at these government agencies that are so uncaring about misuse of taxpayer money? What is Congress doing? What are the prosecutors doing? What are the auditors and the board of directors doing? And, finally, where are the investigative reporters and their editors who are capable of digging into a tough story and blowing the whistle?

Many believe that Enron and WorldCom exposed corporate fraud. The lawbreakers, after all, were prosecuted and Congress came in and passed new, tough antifraud laws. It’s true that many public companies are now more careful and have better financial controls. The problem is that not all the bad guys have been prosecuted, the authorities do not seem to care and investors will get hurt, again.

As bizarre as this seems, in retrospect, this all began as a charity case—a charity called the Tomorrows Children’s Fund. The fund supports a hospital, based in Hackensack, New Jersey, that treats kids with cancer. The charity raises money by hosting an annual investment research conference, where well-known investors share a few stock picks and pans with an audience that pays to attend the event. All proceeds go to the hospital. Though I didn’t consider myself to be well known, I was honored to speak at the 2002 conference. After I learned about the cancer center and the services that it provides to sick children and their families, I immediately knew that this was a cause worth supporting. I would be in special company, and I wanted to do a good job.

I had never given a public speech to a large group of strangers. I really wanted to discuss an idea that would hold the audience’s attention. At that moment, the most compelling idea in our portfolio was to sell short the shares of Allied. Short selling is the opposite of owning, or being
long
, a stock. When you are long, the idea is to buy low and sell high. In a short sale, you still want to buy low and sell high, but in this case the sale comes before the purchase. It works this way: Your broker borrows shares from a shareholder who lends them to you, and you sell them in the market to a new buyer, thus establishing a short position. To close out the position at a later date, you buy shares in the market and return them to your broker to “cover” your short, and the broker returns them to the owner. Your profit or loss is the difference between the price you receive when you sell the shares short and the price you pay to buy them back. The more the stock falls, the more money you make—and vice versa.

At a conference of eleven speakers, I spoke third to last. A number of the speakers before me had superb ideas. Larry Robbins of Glenview Capital explained how General Motors’ long-term pension and health liabilities would become a large problem for the company—this was two years before the subject became front-page news. Bill Miller of Legg Mason recommended Nextel, while Morris Smith, the former manager of the Fidelity Magellan mutual fund, talked about Candies, the shoe company.

By the time I gave my speech about Allied Capital, it was late in the afternoon. The market had closed for trading. After I detailed Allied’s problems, word spread about the speech, and the next morning the company’s stock was unable to open when the market did because there were too many sell orders for the New York Stock Exchange specialist to balance them on time. When the shares did trade, they opened down 20 percent. But the steep decline that day was nothing compared to the plunge I was about to take, spending years uncovering what I view as a fathomless fraud.

This book details the company’s fraud; the regulatory agencies that are failing to do their jobs to stop it; and the stock analysts and reporters who mostly fail to print the truth because they are biased, intimidated, lazy or just not interested. As I wrote to the SEC about Allied in October 2003, allowing Allied to persist in this behavior harms investors and other honest companies that follow the rules.

Allied’s management has had unending opportunities to answer my allegations, and I have not seen them once address the actual facts that form the basis of my allegations. They can’t. Instead, they have cried manipulation. Rather than have me tell you about the speech, you can see it for yourself at
www.foolingsomepeople.com
.