After that talk, which happened to be the first public address he’d ever given, he had actually expected regulators to look into his accusations of fraud at Allied. Instead, the Securities and Exchange Commission started investigating him and whether he was trying to manipulate the market with his comments. For its part, Allied fought back. A private investigator working for the company obtained Einhorn’s phone records through a frowned-upon and potentially illegal approach known as pretexting—that is, pretending to be someone else in order to obtain privileged information about another person.
Einhorn’s battle with Allied had been going on for six years, but today, patient as ever, he would use his bully pulpit to take on a much larger opponent.
Einhorn finally placed his notes on the podium. As he surveyed the crowd, he noticed the glow of dozens of BlackBerrys in the first few rows alone. Investors were taking notes and shooting them back to their offices as quickly as possible.
The markets may have been closed for the day, but in the trading business, a valuable piece of information was worth its weight in gold no matter what the time. There was always a way to make money somewhere.
Einhorn opened his remarks in his slightly nasal Midwestern monotone by recounting the entire Allied story and tying that back to Lehman Brothers.
“One of the key issues I raised about Allied six years ago was its improper use of fair-value accounting, as it had been unwilling to take write-downs on investments that failed in the last recession,” he told the audience. “That issue has returned on a much larger scale in the current credit crisis.”
What he was saying was that Lehman hadn’t owned up to its losses last quarter, and the losses this time were bound to be much bigger.
After laying out his provocative thesis, Einhorn related an anecdote:
“Recently, we had the CEO of a financial institution in our office. His firm held some mortgage bonds on its books at cost. The CEO gave me the usual story: The bonds are still rated triple A, they don’t believe that they will have any permanent loss, and there is no liquid market to value these bonds.
“I responded, ‘Liar! Liar! Pants on fire!’ and proceeded to say that there was a liquid market for these bonds and they were probably worth sixty to seventy percent of face value at the time, and that only time will tell whether there will be a permanent loss.
“He surprised me by saying that I was right. He observed that if he said otherwise, the accountants would make them write the bonds down.”
From there Einhorn segued back to Lehman Brothers and made it clear that he felt the evidence suggested the firm was inflating the value of its real estate assets, that it was unwilling to recognize the true extent of its losses for fear of sending its stock plummeting.
He recounted how he had listened intently to Callan’s performance during her by now famous earnings call the day after the Bear Stearns fire sale.
“On the conference call that day, Lehman CFO Erin Callan used the word ‘great’ fourteen times; ‘challenging’ six times; ‘strong’ twenty-four times, and ‘tough’ once. She used the word ‘incredibly’ eight times,” he noted.
“I would use ‘incredible’ in a different way to describe the report.”
After that rhetorical flourish, he recounted how he had decided to call her. With a projection screen displaying the relevant figures behind him, he told how he had questioned Callan about the fact that Lehman had taken only a $200 million write-down on $6.5 billion worth of the especially toxic asset known as collateralized debt obligations in the first quarter—even though the pool of CDOs included $1.6 billion of instruments that were below investment grade.
“Ms. Callan said she understood my point and would have to get back to me,” Einhorn relayed. “In a follow-up e-mail, Ms. Callan declined to provide an explanation for the modest write-down and instead stated that, based on current price action, Lehman ‘would expect to recognize further losses’ in the second quarter. Why wasn’t there a bigger mark[down] in the first quarter?”
Einhorn explained that he had also been troubled by a discrepancy of $1.1 billion in how Lehman accounted for its so-called Level 3 assets—assets for which there are no markets and whose value is traced only by a firm’s internal models—between its earnings conference call and its quarterly filing with the SEC several weeks later.
“I asked Lehman, ‘My point-blank question is: Did you write up the Level 3 assets by over a billion dollars sometime between the press release and the filing of the 10-Q?’ They responded, ‘No, absolutely not!’ However, they could not provide another plausible explanation.”
Clearing his throat audibly, Einhorn ended his speech with a warning.
“My hope is that Mr. Cox and Mr. Bernanke and Mr. Paulson will pay heed to the risks to the financial system that Lehman is creating and that they will guide Lehman toward a recapitalization and recognition of its losses—hopefully before federal taxpayer assistance is required.
“For the last several weeks, Lehman has been complaining about short-sellers. Academic research and our experience indicate that when management teams do that, it is a sign that management is attempting to distract investors from serious problems.”
Within minutes of Einhorn’s leaving the stage, news of his speech had been broadcast throughout financial circles. Lehman was in for some serious pain when the market opened the following day; the shares would fall as much as 5 percent.
As Einhorn headed up Broadway to attend a book party being thrown for him at the restaurant Shun Lee West, he leafed through the program of the conference he had just left and saw something that made him smile ruefully.
Lehman Brothers had been one of the Patron Sponsors of the conference, having paid $25,000 so that the world could hear him publicly undermine the firm’s credibility.
CHAPTER SIX
“Who talked?” Dick Fuld demanded, scarcely able to control his fury and looking as if he might leap across the table and strangle someone.
Lehman’s executive committee—the firm’s top managers—were arrayed around a conference room table on Tuesday, June 3, awkwardly sitting in absolute silence.
Fuld held a copy of that day’s Wall Street Journal in his hand. There, on the front page, was what he described to them as “the greatest betrayal of my career.” He had practically choked that morning when he read the headline—“Losses Push Lehman to Weigh Raising New Capital”—with the story adding the damning details: “Wall Street executives estimate it is likely to be $3 billion to $4 billion. They said Lehman would probably announce the capital raising in conjunction with its quarterly results.”
There it was, the morning’s news, the secret plan he had been working on for the past month to counter the critics and demonstrate strength, exposed for the entire world to read. He had been working frantically to shore up the firm, and now, he thought, the leak put all that effort in jeopardy.
Fuld had spoken to the reporter Susanne Craig on and off the record many times over the last few months. But he’d certainly never breathed a word of this. Fuld could only take solace in the fact that she didn’t have all the facts of his plan just yet: Lehman was in discussions with the Korea Development Bank, a state-owned policy bank in South Korea. The talks, which were being orchestrated by Kunho Cho, Lehman’s top executive in Seoul, could lead to a major cash infusion of more than $4 billion. Still, Fuld knew that the only way Craig could have learned that the firm was considering seeking new capital was if someone in the know—someone at the table in the conference room that morning, in fact—had leaked the story.