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A Hedge Fund Manager's Crusade To Expose Losses

The people who run hedge funds can be famously secretive about their work. Not David Einhorn.

Einhorn founded Greenlight Capital, which manages about $6 billion in assets. He recently waged a very public battle against Lehman Brothers, claiming it was losing more money than it admitted. He turned out to be right.

Now he's written a book, Fooling Some of the People All of the Time, about his six-year battle against another company, Allied Capital. Einhorn says the experience shows how the media and financial regulators can sometimes fail investors.

Each May, hundreds of Wall Streeters show up at the Ira Sohn Investment Research Conference in New York's Lincoln Center. They pay up to $3,200 each for the chance to hear advice from big investors like Carl Icahn and Wilbur Ross. One of the speakers this year was the brainy, boyish, 39-year-old Einhorn, whose hedge fund has racked up some impressive gains over the years. Einhorn began his speech with some unfinished business:

"I want to go outside the usual format for this investment, and for this conference, and ask this audience, by applause, who agrees with me that there should be some significant consequence for the folks at Allied Capital for what they've done?" The crowd applauded and Einhorn continued: "Thanks; there's a lot of people here; there's a lot of media people here. I want them to hear it."

Critical Research

You might say Einhorn is on a kind of crusade. Six years ago, at this very conference, he began talking about accounting problems at a Washington, D.C.-based company called Allied Capital. He's still doing so today, at some personal cost.

"The effects of the pushback have been tremendous, there's no question about it," he says. "It's expensive; it's been not that pleasant; certainly it's a deterrent toward other people standing up and discussing critical research about companies."

Sitting in a dressing room after the speech, Einhorn says he first heard about Allied Capital when he was researching stocks to buy. Allied is a business development firm that makes loans to medium-sized companies. Einhorn came to the conclusion that Allied was misstating the value of the loans it had issued using accounting tricks. Einhorn, who is also a well-regarded poker player, figured that when he laid out his case against Allied in detail, regulators and the media would go after the company.

Former journalist Herb Greenburg, who runs a research firm, believes Einhorn made a strong case against the company. And its stock price fell. But then Einhorn himself came under attack.

"What so many people on Wall Street don't want to even think about is what the risk is, and that's what David was doing — he was pointing out the risk," says Greenburg.

Federal Regulators Take Notice

Allied denied Einhorn's allegations. It noted that Einhorn had shorted the company's stock. That meant he would benefit if its value fell. They said by going public with his charges, he was trying to manipulate the price.

Einhorn replied that yes, he was not exactly a disinterested observer. But neither were the managers defending the company. They owned stock and wanted to see it rise. That argument aside, Einhorn found himself called in for an interview with the Securities and Exchange Commission.

"So the first thing the regulators did, I think, was investigate us for the speech and whether the speech was some effort to manipulate the stock," says Einhorn. What did Einhorn make of the investigation? "It was Kafkaesque. It was backward," he says. "It was investigating the whistle-blower, rather than investigating the claims."

Fallout From Speaking Out

The SEC would not comment about the case now; it never brought any charges against Einhorn. But Einhorn has paid a price in other ways. A columnist for The Wall Street Journal likened him to a mugger. His wife was asked to leave her job. And Einhorn discovered that an agent hired by a company employed by Allied had illegally accessed his phone records.

Allied says it didn't know the agent did this. Allied also says that despite federal investigations and shareholder lawsuits, no third party has ever validated Einhorn's claims. Christopher Davies, an attorney for Allied, says the SEC did cite the company for bookkeeping violations, but they were minor.

"Neither of these findings support Mr. Einhorn's inflammatory allegations that Allied has overstated its investment portfolio," Davies says. "In fact, the SEC did not impose any penalties or financial disgorgement, nor did it require that Allied restate its historic financial results or any valuation of its investments."

Einhorn replies that the SEC has an indifferent record when it comes to pursuing fraud at companies unless they've clearly imploded, like Enron.

"So investors should be aware of this, and they should realize that the only person watching out for them is not these Wall Street analysts and not these corporate managements, but they themselves," Einhorn says. "So they need to have appropriate skepticism as they put their money at risk in the market."

Allied's shares have fallen sharply in recent months. The company's stock closed at $13.06 on Tuesday, down from its 52-week high of $33.35. After six years, Einhorn continues to hold a short position on the stock, betting it will drop further.

But Einhorn's campaign against Allied has had mixed results. He notes that since that first speech six years ago, Allied has issued new stock numerous times. Einhorn has done his best to lay out a strong case against the company. But so far, at least, a lot of investors have been willing to look the other way.

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Jim Zarroli is an NPR correspondent based in New York. He covers economics and business news.