The U.S. attorney's office in the District is conducting a criminal investigation related to Allied Capital Corp.'s investment in its single largest holding, a New York small-business lender, Allied said yesterday.
Allied, a publicly traded company that lends money to and invests in mid-size private companies, said it received letters last week from prosecutors requesting that the company preserve and produce documents pertaining to its relationship with Business Loan Express LLC.
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In a statement, District-based Allied said the criminal investigation "appears to pertain to matters similar to those allegations made by short sellers over the past two and one-half years." Short sellers, who profit when a company's stock drops in value, have for years criticized the way Allied values its loans and investments.
The company disclosed on June 24 that the Securities and Exchange Commission was conducting an inquiry into the Business Loan Express matter. Allied officials said they were cooperating with the inquiry and were confident they had done nothing wrong.
"Over the last two years, we have consistently refuted frivolous allegations made by short sellers based upon false and misleading information and distorted facts," Allied chief executive William L. Walton said at the time.
Walton could not be reached for comment yesterday. A company spokesman declined comment beyond the brief statement, citing the possibility of a criminal probe.
The short sellers, led by New York hedge fund manager David Einhorn, continue to raise questions. Einhorn marshaled a two-year private investigative effort that uncovered an unusual, $9 million transaction that is part of the SEC probe, according to a source who agreed to speak only without being identified because of the federal inquiries. Einhorn also personally lobbied the SEC and the Small Business Administration to conduct their own inquiries into Allied, the source said.
Business Loan Express is one of the country's largest independent SBA lenders. Though Allied controls 95 percent of BLX, the SBA lender still counts as a separate and distinct company because of the way Allied is regulated by the SEC.
Allied took effective control of BLX in 2000, selling its own SBA lending company to BLX at the same time. In that deal, BLX assumed some troubled Allied loans with a face value of $9 million. In 2003, as part of a $300 million recapitalization of BLX, Allied took back the troubled loans in exchange for retiring $9 million of BLX's debt to Allied. After taking the loans back, Allied wrote their value down by $6 million. Allied did not disclose the loan swap until April 2004.
Einhorn and some independent research analysts say the transaction appeared designed to inflate the value of BLX by $6 million, and could also have been used to hide potentially fraudulent SBA loans. Allied said the loan transfer was part of a verbal agreement it had with BLX's chief executive to protect that company's standing with the SBA. Also, the loan write-down, whether on BLX's books or on Allied's, had the same net effect on Allied's net worth, Allied officials said.
The day Allied disclosed that the SEC was reviewing the transfer, investors shaved $2.70 off Allied's stock price. Yesterday, Allied closed at $25.61, down $2.63.
David M. West, a Davenport & Co. analyst, said he was concerned about the escalation of the case from a civil matter at the SEC to a criminal one. "The chief thing I'm curious about is why the U.S. attorney would feel the need to look at this from a criminal standpoint," he said.