Greenlight's Einhorn Shorting Lehman

Speaking Wednesday [May 21] at the 13th Annual Ira W. Sohn Investment Research Conference in New York, Mr. Einhorn said he was short Lehman Brothers stock because he remains skeptical about Lehman’s accounting...
In a book published by Wiley to be released this month called Fooling Some of the People All of the Time: A Long Short Story, Mr. Einhorn gives a detailed narration of his multi-year clash with Allied. The book depicts the manager’s skepticism of the integrity of Wall Street, which he said is more eager to accuse short sellers of conspiring against corporations than it is to scrutinize companies’ financial statements. By making the case against Lehman, the fourth-biggest U.S. securities firm, Mr. Einhorn appears to be preparing to fight the same battle again only with a different and bigger opponent.

... the Lehman story is a sensitive one. In March, as Bear Stearns Cos. Inc. was slowly sinking under the double blow of short sellers and creditors’ pullouts, Lehman was rumored to be next.

But during an earnings conference call on March 18, a day after Lehman’s stock price fell 20% as a result of the Bear Stearns’ bailout announcement accompanied by negative rumors about Lehman, Erin Callan, chief financial officer at Lehman, stood up and answered analysts’ questions in a frank and straightforward fashion. ...

As a meticulous forensic accountant, Mr. Einhorn criticized Lehman’s financial statement procedures and made his bearish case at the conference. He was just short of saying that Ms. Callan’s explanations were disingenuous.

“They have $6.5 billion in [collateralized debt obligation] exposure. Approximately 25% of the positions held on Feb. 29 [2007] and Nov. 30, 2007 were rated double B+, or below investment-grade, by recognized rating agencies,” he said. “I asked: You have $200 million write-downs on $6.5 billion CDOs that include 25% below investment-grade?”

Mr. Einhorn also looked at the amount of so-called Level 3 assets disclosed by Lehman between its fourth quarter last year and this year’s first quarter. According to FAS 157 accounting rules, Level 3 assets are completely illiquid, and thus are nearly impossible to price. Mr. Einhorn said that in the fourth quarter, Lehman disclosed in its 10Q filing with the Securities and Exchange Commission $38.8 billion worth of Level 3 assets followed by $40.2 billion in the first quarter for that same category.

“But those 10Q changes did not reflect what the company announced in its conference calls and press releases,” Mr. Einhorn said. He said that when mentioning the discrepancy to Lehman’s management, he was told that gaps sometimes exist between 10Qs and earning calls. He said that he was not convinced by the explanation.

Mr. Einhorn’s final charge was that Lehman’s total disclosed write-downs for its mortgage assets are less than what they should be given the bank’s exposure to those assets.

A Lehman spokesman declined to comment on any of those points, but insiders at Lehman were obviously not happy about the speech.

Depending on one’s position on the stock, Mr. Einhorn’s exposé will be seen either as an attack or a work of serious research, but one can predict that Mr. Einhorn will stick to his guns. At a time when the market is trying to assess the real value of the losses incurred by banks and other financial institutions, the tales of short sellers may gain more credibility as the market tries to make sense of financial statements that sometimes disclose and sometimes hide the amount of exotic and toxic assets.

Too often, Mr. Einhorn complained, Street analysts take the contents of upbeat press releases at face value, relying on the accuracy of financial statements without doing their homework. Worse, he said, hedge funds that short stocks in a bear market often are perceived as the villains, when their role as whistle blowers should instead be respected.

As the battle between Overstock.com Inc. Chief Executive Patrick Byrne and the short sellers in his company shows, there is an anti-short seller sentiment that prevails on many corners of Wall Street, one that corporations such as Overstock have been sure to exploit.

In order to defend itself, Lehman also tapped into the popular aversion to shorts, announcing last month that it notified the SEC about bear raids and malevolent rumors instigated by hedge funds and short sellers trying to bring its stock price down. ...

Mr. Einhorn’s thesis has a gap. To Lehman’s credit, the $6.5 billion in CDO exposure reported in the first quarter represented non-residential mortgages—in other words, CDOs backed by franchise loans, whole business securitization loans, auto loans and credit card loans. The portion of the collateral made of residential mortgages—the riskiest assets—account for only $900 million, according to Lehman.

But this point looks like a small gap compared to Mr. Einhorn’s main point, which is that a quarter of Lehman’s CDO book was rated below investment grade. Lehman’s problems are far from over. While the bank may not be the next Bear, it is now facing a second round of problems...