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) 📖

speech in 2008, the markets and the economy sharply deteriorated, leaving Lehman little room to maneuver. In contrast, after my Allied speech in 2002, the economic and capital market recoveries bought Allied years of additional time—time it used to massively expand its business and, ultimately, bilk the taxpayers and its investors out of hundreds of millions of additional dollars.

CHAPTER 37

If They Asked Me, I Could Write a Book

As mentioned in the Introduction, Allied’s lawyers sent a number of letters to both John Wiley & Sons and me hoping to stop this book’s publication. For months, both sides suggested meetings, though never on mutually agreeable terms. On April 8, 2008, just four weeks before the May 5 publication date, Allied’s lawyer sent a five-page letter to Wiley complaining about the book’s promotional copy, pointing out, among other things, that “corporations do not lie; people do,” and asserting that Wiley had no right to publish libelous statements that damage Allied’s reputation.

In response, my lawyer sent them a copy of the book, with a note offering, “Should you or your client identify any actual inaccuracies, please advise us and we will promptly correct any errors.”

We never heard back directly, but just a few days after Wiley sent prepublication copies of the book to reviewers, Allied issued a press release that began, “Allied Capital Corporation announced today that Joan M. Sweeney, Chief Operating Officer, intends to retire from the Company at the end of 2008.” Given the damning evidence in Fooling Some of the People, it was not surprising that Allied would want to distance itself from Sweeney.

To the media, Allied said this about the book: “Allied Capital has had to endure Mr. Einhorn’s relentless, self-serving campaign for seven years, and during that time no independent third party has concluded that his portrayal of Allied Capital has merit.” Even this narrow statement was false. In 2007, the SEC had found that Allied could not support its loan valuations, the SBA had declared BLX to be the largest fraud in SBA history, and Patrick Harrington, a former Allied/BLX executive, was on his way to jail. (In November 2008, he was sentenced to 10 years in prison.)

Still, given all the prepublication saber rattling, when Walton announced the first-quarter results in the May 2008 conference call, I braced myself. A 30-minute rant seemed as likely as an announcement that Allied was preparing legal action against John Wiley & Sons and me. What I didn’t expect was silence—Walton chose not to mention the book at all. And in a continuation of the Kabuki theater that exists between management and analysts, no one else on the call chose to mention the book, either.

The summer of 2007 marked the beginning of the turmoil in the credit markets. The changing environment forced Allied to step up its stock offerings, providing the necessary cash to keep paying dividends. In January 2008, it sold four million shares at $22.00 in an overnight offering underwritten by Morgan Stanley. In March it sold another four million shares at $20.35 in the same manner through Merrill Lynch. Then, in May, just after Fooling Some of the People was published, Citi, Deutsche Bank, Merrill Lynch, and Morgan Stanley teamed up to sell nine million shares at $20.45 each. Altogether, the regulatory failures at the SEC allowed Allied to bilk unsuspecting investors out of an additional $350 million.

Days after the May offering, while speaking to a senior Morgan Stanley executive about another matter, I asked how his firm felt about going forward with an Allied stock sale in light of this book. He assured me that the underwriting committee at Morgan Stanley had had a thorough discussion about my concerns before proceeding. I asked whether anyone on the committee had actually read the book. He told me that no one had.

Even as Allied continued its public offerings, it was preparing for disaster. Prior to the April shareholders meeting, Allied asked stockholders to approve a proposition authorizing the company, with approval of its board of directors, to sell shares of its common stock at prices below the company’s then-current net asset value per share in one or more offerings. Regulations forbid business development companies (BDCs), such as Allied, from selling shares below net asset value (NAV) without shareholder consent. Allied argued that it would be in the shareholders’ interest to raise capital—even at a discount—so that Allied could take advantage of “favorable opportunities” that might arise. In reality, it needed the infusion of new money to keep the pyramid from crumbling. The proxy advised:

If the Company were unable to access the capital markets as attractive investment opportunities arise, the Company’s ability to grow over time and continue to pay steady or increasing dividends to stockholders could be adversely affected. It could also have the effect of forcing the Company to sell assets that the Company would not otherwise sell, and such sales could occur at times that are disadvantageous to sell.

Since Allied’s shares were trading above NAV and had done so for many years, management had a hard time convincing shareholders to support the proposal. In a moment of poetic justice, Allied had done too good a job persuading its owners that it wasn’t a pyramid scheme. At the shareholder meeting in April 2008, management could not muster sufficient support to approve the discounted equity sales. Allied adjourned the meeting until May to give itself more time to find the necessary votes. Failing again, it adjourned the meeting until June in a last Hail Mary attempt to get the shareholders on board. It failed a third time. Walton blamed the defeat on Allied’s two-thirds retail shareholder base, suggesting that obtaining voting instructions can be difficult. Despite his claim, I can’t recall Allied having trouble obtaining shareholder approval on any other proposals.

There was no more new money to be had, and things began to unravel.

Allied’s inability to tap the equity markets to raise cash came just as the economy began to impact Allied’s portfolio. In the first