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) 📖

I had to pinch myself. I scrambled to make sure I was not mistaken. I got a picture of Braswell from his new firm’s Web site, and, yes, he was the same guy in the SEC interview room. Greenlight’s lawyers also went through their notes and confirmed Braswell’s attendance. We asked the SEC for a transcript of my testimony, which removed any remaining doubt.

Norris wrote a column on July 15, 2005, describing Allied’s recent decision to stop reporting BLX’s summary financials and its hiring of Braswell as a lobbyist. Norris wrote:

Calling Business Loan Express, and most of Allied’s other operations, “private companies” strains credulity. In reality, they are subsidiaries of Allied, which owns all or nearly all of their stock. But Allied treats them as investments and discloses as little information as it can. It can do that because it is classified as a business development company.

Companies that hide facts invite suspicion. In 2002, Greenlight Capital, a hedge fund run by David Einhorn, published a report questioning Allied’s accounting. Mr. Einhorn soon found himself being questioned by enforcement lawyers from the Securities and Exchange Commission, and he blames Allied for complaining about him.

One of the SEC lawyers doing the questioning, Mr. Einhorn says, was Mark K. Braswell, who is now a partner in the Venable law firm in Washington. Last fall, after Allied disclosed the SEC had started an informal inquiry into Allied’s books, he registered as a lobbyist for Allied. (© 2005, The NewYork Times Company. Reprinted with Permission.)

Norris said that Braswell wouldn’t tell him what kind of work he was doing for Allied, but said “he did not represent it in the government investigations and had made no inappropriate disclosures to Allied about SEC cases. He said he followed all ethics rules.”

Norris also noticed the curious shareholder behavior. They didn’t seem to care that Allied was withholding information or anything else they did as long as the distribution kept coming. “The shareholders do not appear bothered by the fact Allied keeps the financial results of its wholly owned subsidiaries secret,” he wrote. “The question is whether the SEC will do anything about Allied’s decision to hide even more information from its owners.” Allied’s stock, which traded around $29 a share at the time, did not react to Norris’s story.

Meanwhile, Allied gave the appearance of cleaning up its act. After a few years of gradually writing down the problems created in the recession and with the benefit of improved conditions in the capital markets, Allied had fewer absurd valuations, such as loans to bankrupt companies carried at cost. Allied improved the optics of its valuation process. First, it promoted a long-standing senior executive to the new title of “chief valuation officer.” Obviously, promoting an existing manager, who might have been part of the problem, was unlikely to solve the problem. Second, it hired Duff & Phelps and JMP Securities to provide “valuation assistance.”

Valuation opinions are often for sale on Wall Street. For obvious reasons, the “valuation assistance” Allied sought was far less than appraisals or fairness opinions for its investments. The valuation firms were not retained to perform due diligence on the companies, visit them, speak to their managements and so forth in order to recommend a value to Allied. According to Duff & Phelps’ standard engagement letter, it “will not be responsible for determining Fair Value.” Its role “is limited to being an advisor and providing additional support to your existing valuation policy and process as well as providing negative assurance with respect to the Fair Value determined by management for each investment.”

Instead, Allied provides its own valuations to Duff & Phelps for review. For about $5,000 a company, Duff & Phelps looks at Allied’s work and without independently checking facts it provides a “negative assurance”—meaning that assuming that the information Allied provided is accurate and complete, Duff & Phelps advises that the valuations are not unreasonable. Of course, if Allied management picks and chooses which facts it shares with Duff & Phelps, its valuation consultant has no basis or authority with which to disagree.

At only $5,000 per company, Duff & Phelps is not being paid enough to do a sufficient amount of work and research. Appraisals would probably cost at least ten times more. Indeed, according to its standard agreement Duff & Phelps performs only “limited procedures” of reading and discussing management’s prepared valuations and related write-ups, meeting with the deal teams to understand management’s expectations and intent for each investment and to discuss the underlying company’s strategy and performance. It considers general economic and industry trends, publicly traded comparable companies, the financial information provided by management and “other facts and data that are pertinent to the companies as disclosed by management.” Duff & Phelps checks management’s calculations for clerical accuracy. Finally, it speaks with auditors and underwriters about “any questions they may have regarding the limited procedures.”

Though Allied improved the optics of its process, the various red flags such as performance smoothing and serial correlations of the valuations persisted. We had sufficient information about several of Allied’s investments to know that Allied still valued them at prices for which it had no reasonable basis. Of course, as long as the mother ship of misvaluation, BLX, continued, there was little reason to take the “valuation assistance” too seriously.

We did brokerage business with JMP Securities, one of the firms Allied retained to assist in the valuation of BLX. I called Greenlight’s salesman at JMP and asked to speak with whoever was doing the work on Ailled. JMP refused. I offered to do it on the basis that I would speak and JMP would only have to listen. Again, JMP declined. The JMP salesman noted, “We aren’t saying to buy Allied stock, you know.”

Allied’s results were getting weaker. The company distributed more per share than it reported