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Lehman Battles an Insurgent Investor

Louise Story|The New York Times
Wednesday, 4 Jun 2008 | 11:13 AM ET

David Einhorn thinks another big Wall Street bank is headed for trouble — and he is not being quiet about it.

For eight months now, Mr. Einhorn, a rabble-rousing hedge fund manager, has pilloried the venerable Lehman Brothers in an effort to drive down the bank’s stock price, which he is betting against.

Lehman Brothers is not amused. In recent weeks, the bank’s chief financial officer, Erin Callan, has tried privately to rebut Mr. Einhorn to nervous investors, who have feared for Lehman’s health ever since Bear Stearns succumbed to a panic. But despite Ms. Callan’s efforts, Lehman’s stock keeps falling: It tumbled 9.5 percent more on Tuesday, in a deluge of selling, bringing its loss for the last 12 months to 59 percent.

Hedge Fund Leery of Lehman
Shares of Lehman Brothers have fallen 14% in the last week, accelerated by the critical words of David Einhorn, president of Greenlight Capital. Mr. Einhorn discusses Lehman with CNBC's Maria Bartiromo.

The battle over Lehman has captivated Wall Street and left the bank struggling over what to do next. The bank, which is expected to post a quarterly loss of roughly $1 billion in a few weeks, may also raise capital to shore up investor confidence. The bank has sold more than $100 billion in assets in recent months to shore up its finances, according to a person close to the company. That person said new capital would most likely come from a source other than the public markets.

Mr. Einhorn, who runs a $6 billion hedge fund called Greenlight Capital, has been profiting from the Lehman’s growing pain. Critics say he is needlessly fanning fears about the precarious health of the financial industry at the very moment executives are struggling to stabilize their ailing companies. Many on Wall Street still wonder if hedge funds like Greenlight helped bring down Bear Stearns and spread false rumors about the bank, a possibility the Securities and Exchange Commission is investigating.

In an interview on Monday in his Midtown offices, Mr. Einhorn, fresh from his latest round of television appearances, said he was not out to tell Lehman Brothers how to fix its problems. He questioned how the company valued the assets on its books, and whether it was disclosing all the risks it faces. Investors have good reason to question banks: Worldwide, financial companies have suffered more than $380 billion in write-downs and credit-related losses in the last year, laying bare their shoddy risk management. Lehman has been singled out because of the large role it played in the mortgage market and its reluctance to disclose information about its assets compared with other Wall Street banks.

“Lehman has been one of the deniers,” Mr. Einhorn, 39, said.

Mr. Einhorn said he began betting against Lehman’s stock last July, and he has been right so far. But things have not always gone his way. His long battle against the Allied Capital Corporation prompted the S.E.C. to investigate comments he had made about that company, an episode he discusses in his new book, “Fooling Some of the People All of the Time,” which he is busy promoting. And he was a board member and longtime fan of the New Century Financial Corporation, a big subprime mortgage company that filed for bankruptcy last year.

Still, Mr. Einhorn could be a thorn in Lehman’s side for years to come. For six years he has been using a short trade as a way to bet against a rise in the stock price of Allied Capital and MBIA, the bond reinsurance company.

“He’s got a lot of conviction, and he persists in his convictions for a long time,” said Adam Zoia, managing partner of Glocap, a recruiter in New York that has worked for Mr. Einhorn.

Mr. Einhorn instigated the latest dive in Lehman’s stock price two weeks ago when he encouraged other investors to short the stock at a large conference in New York. When Standard & Poor’s lowered its debt rating for Lehman and several other Wall Street banks on Monday, Mr. Einhorn joined the ratings agency’s conference call on Tuesday and asked whether the agency reviews Lehman’s valuations of its assets.

Ms. Callan, 42, spent an hour on the phone with Mr. Einhorn answering questions before his speech. Afterwards, she found herself rebutting some of his assertions to investors.

On Tuesday, Lehman issued a public statement denying market rumors that it had turned to Federal Reserve for cash through a special program put in place after Bear Stearns collapsed. Ms. Callan and other Lehman executives declined to comment on Mr. Einhorn for this article.

It is impossible to quantify Mr. Einhorn’s influence on Lehman’s stock price. But hours before his speech two weeks ago, trading volume exploded for Lehman stock puts, which are options to sell the stock and profit if its falls. That day, more than 200,000 put contracts against Lehman were sold, up 49 percent from recent typical Lehman put trading.

Brad Hintz, the banking analyst at the Sanford C. Bernstein & Company and Lehman’s former chief financial officer, said he could hardly walk a few feet at a conference at the Waldorf-Astoria last week without having investors ask him about Mr. Einhorn’s views.

Einhorn "cherry picks" information, says Lehman

Lehman’s management has spoken with some analysts about Mr. Einhorn, but they have declined to comment publicly beyond a statement that says Mr. Einhorn “cherry picks” and misconstrues information.

“They’re furious,” Mr. Hintz said. “If you get distrust of your accounting, then it affects the valuation of the company forever going forward.”

Within Lehman, workers are calling Mr. Einhorn’s strategy “short and distort.” Many hedge fund managers talk freely with one another about companies, but they typically shun publicity. Mr. Einhorn, by contrast, is working with a financial public relations firm, the Gordon Group, to promote his book and views on stocks.

“His position on shorting Lehman is only going to get traction and be successful if he can succeed in convincing people to drive down the stock,” said Michael Claes, a managing director at the public relations firm Burson-Marsteller. “That’s best accomplished with media exposure.”

But Mr. Einhorn’s public approach leaves him open to being criticized himself. Mr. Hintz of Sanford Bernstein said in a report on Monday that supporters of Mr. Einhorn’s latest arguments are “piling on” against Ms. Callan. And Buckingham Research Group said his concerns were “just wrong.”

“These recent criticisms also seem will-timed to take advantage of the market’s concern around weak second-quarter results that we expect for Lehman,” the Buckingham analysts wrote in a report.

Lehman, to be sure, will have to explain its second-quarter earnings to be announced in the next two weeks. Ms. Callan has said the bank will take more write-downs and that some hedge trades were not effective.

Lehman, like its counterparts, is racing to use less leverage. The bank had a gross leverage ratio of 31.7:1 at the end of the first quarter, meaning it had borrowed $31.70 for each dollar of equity. Lehman has whittled that ratio down to 25:1 through its more than $100 billion in asset sales, said the person close to the company who was given anonymity because he was discussing a pending financial filing. A small amount of the sales were to two hedge funds set up by former Lehman executives.

Mr. Einhorn likes to point out that Lehman’s management has incentives to be positive since compensation is tied to performance. Short sellers, he said, receive undue skepticism, and he said he thought he would be getting far less attention if he were discussing a positive view on a company.

Aside from Lehman, Mr. Einhorn would not say if he is long or short other financial companies. But Greenlight Capital has twice as much money invested in long positions across its entire portfolio than it does shorts, he said. So a collapse of Lehman that turned into a broad economic panic could hurt Mr. Einhorn, too.

He said he would keep the Lehman trade going until he is proven right — or wrong.

“The faster the better,” Mr. Einhorn said, “but the world doesn’t work on my schedule.”

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