Fooling Some of the People All of the Time, a Long Short (And Now Complete) Story, Updated With New David Einhorn (best classic books of all time .TXT) 📖

later at a lower price, return the stock to the lender, and keep the profits. Brickman and Greenlight Capital thus stand to benefit from any decrease in the price of Allied stock that may result from this lawsuit.”

Though this finding supposedly had nothing to do with her decision, her gratuitous adoption of the irrelevant and misguided attack by BLX’s lawyers on our motives for filing the suit particularly galled Brickman; he hadn’t been short Allied for years and said so in our court filings.

Allied rushed out a celebratory press release, noting the judge’s findings relating to our motives, trumpeting, “Shortsellers of Allied Capital shares, including David Einhorn and his allies, have for many years been making false and unsubstantiated claims of wrongdoing against Allied Capital and BLX. So far, every court that has ever examined the shortseller claims has rejected them.”

Of course, Allied saw no need to acknowledge that the court hadn’t even considered the merits of the case. Indeed, the court never ruled that BLX did not carry out a fraud in its shrimp boat loans; it simply never reached the issue. The sad irony of Judge Carnes’s ruling, and Allied’s public gloating, is that Allied won this round in the litigation only because the judge ruled that the massive fraud had been a matter of public record for years. Brickman and Greenlight’s appeal of the dismissal was rejected in a one-page ruling.

In December 2007, The Washington Post ran an article by Gilbert M. Gaul on the Bill Russell Oil fraud in the USDA loan program. The article reported on the fraud involving the loans made to the company by BLX as I discussed in Chapter 25, but with a few more details. The article also pointed out the poor government oversight in response to the fraud.

The article reported:

A Washington Post analysis found that from 2001 to 2006, the USDA had to pay $34 million to buy back 13 BLX loan guarantees—representing one of every five USDA-backed loans made by BLX. The 13 loans included some to companies that were in and out of bankruptcy, saddled with tax bills, or struggling in declining industries.

A Maryland gas station operator received a $3 million guaranteed loan but soon lost its license for failing to pay millions in gasoline taxes. It defaulted on the loan and filed for bankruptcy two years later. A Pennsylvania mushroom farm received a $3.4 million loan while in bankruptcy and a loan of $1.7 million a few years later. It filed for bankruptcy again this year and is now defunct. A Hanover, Pa., wallpaper manufacturer with mounting losses got a $3 million guaranteed loan in November 2000. It filed for bankruptcy in 2005 and closed.

In each case, USDA officials relied on BLX employees to investigate the borrowers, conducting little due diligence on their own. Now, with questions being raised about BLX loans to Bill Russell Oil and others, USDA officials have turned to their inspector general to audit the company’s entire portfolio of loans. BLX could be asked to pay back millions.

The article pointed out how Bill Russell Oil borrowed $3 million from BLX through the USDA loan program, despite the Environmental Protection Agency’s citing Bill Russell for dozens of environmental violations and proposing a fine of $314,558.

The article said:

Shirley A. Tucker, the USDA’s director of business programs in Arkansas, said her office relied on the borrower and the lender to certify that Bill Russell Oil met all environmental requirements. Tucker added that she did not learn about the EPA investigation until she read about it in a local newspaper several months after the loan guarantee was approved. “I was surprised,” she said. “Under the conditional agreement, it was up to the lender to bring that to our attention.”

The loan was declared delinquent within a year. “It was hard to see how a loan could go south so fast,” Tucker said. Later, she went to look at some of the gas stations herself. “We found some didn’t have electricity on the day we closed the loan. There was no way they were operating,” she said. (© 2007, The Washington Post. Reprinted with Permission.)

He closed the article with an amazing statement from Tucker: “Yeah, we’re the government, but we really don’t have any enforcement. We can’t put them in jail.”

CHAPTER 34

Blind Men, Elephants, Möbius Strips, and Moral Hazards

If someone commits fraud, but shareholders don’t lose money and the regulators decide to ignore it, was it really fraud? The authorities are good at cleaning up fraud after the money’s gone. After a blow-up, with investors’ capital already lost, they know just what to do. If the blow-up is big enough, like Enron, they form a special task-force and pursue criminal cases against the insiders.

I recently attended a small presentation made by one of the Enron prosecutors. He laid out exactly how he made his case and the mistakes management had made, both in perpetrating the fraud and defending themselves at trial. I asked him if it were fair for Enron management to go to jail, when there are many other management teams that act as Enron’s did or worse, but don’t suffer the same prosecution because their companies haven’t “blown-up.” He really didn’t have an answer.

The authorities really don’t know what to do about fraud when they discover it in progress. The Arthur Andersen prosecution, which put the audit firm out of business for bungling Enron, cost a lot of innocent people their jobs. The government doesn’t want another Arthur Andersen. It seems that the regulatory thinking, espoused by current SEC chairman Christopher Cox, is that shareholders should not be punished for corporate fraud, because he believes they are the victims in the first place. Why punish the victims a second time? This thinking may be politically expedient in the short term, but creates a classic moral hazard—a free fraud zone. If regulators insulate shareholders from the penalties of investing in corrupt companies, then investors have no incentive to demand honest behavior and worse, no need