Shares of Allied Capital (NYSE: ALD) tanked today after the company announced that it might default on its revolving credit facility and its private notes. The company is in discussions with its creditors about possible amendments, but said that a default could have a material impact on its operations and prevent the company from paying its historically high dividends.

What makes watching the demise of Allied Capital so interesting is that the company's flawed business model was exposed in obsessive detail in a book by hedge fund manager David Einhorn.

In spite of the overwhelming evidence that Einhorn compiled, his criticisms were mostly dismissed by Wall Street analysts and regulators -- to the detriment of the company's investors.

Most followers of Allied Capital dismissed Einhorn as a disgruntled short seller with an agenda: If Allied Capital shares went down, he stood to make a lot of money. But the bottom line was that the evidence Einhorn presented mostly spoke for itself, and investors were only cheating themselves by dismissing him as a shortseller.

Problems at Allied Capital (NYSE: ALD) -- the target of short seller David Einhorn's book Fooling Some of the People All of the Time -- continued yesterday with the announcement that one of its portfolio companies, Ciena Capital LLC had filed for chapter 11 bankruptcy protection.

Ciena's predecessor company -- Business Loan Express -- is under fire from federal prosecutors who allege that the company participated in deals designed to defraud the United States government.

What's so interesting about this mess is that a) If you read Einhorn's book, he pointed out serious problems at Business Loan Express far before Ciena was admitting to them, and b) The SEC appears to have completely dropped the ball on this case, resulting in substantial losses to investors.

It's also interesting to note that Overstock (NASDAQ: OSTK) CEO Patrick Byrne's self-proclaimed investigative journalism site DeepCapture, which serves mainly to attack anyone who criticizes Byrne's company or his ideas, has been rallying to Allied's defense in recent months. One of the site's reporters, Mark Mitchell described (PDF) Allied, Overstock, and Novastar Financial as "victims" of a supposed conspiracy of hedge funds and corrupt reporters hell bent on destroying them.

With the Allied mess unfolding much as Einhorn predicted and Novastar on the brink of bankruptcy in the wake of numerous investigations and revelations of shoddy lending practices, it's bad news for Dr. Byrne if Overstock is to be judged by the company it keeps.

Of the 50+ business-related books I read each year, maybe 15 were worth reading, in retrospect. Then another five of those are memorable -- in a good year. Hedge fund manager David Einhorn's book Fooling Some of the People All of the Time leapfrogs both of those categories, and establishes itself as a classic of business writing.

The story behind the book is intriguing. It's actually amazing that it ever got published, and tremendous credit should be given to Wiley for taking a chance with such an unconventional tale. Here's the deal: In a 2002 speech at a charity event, Greenlight Capital hedge fund manager David Einhorn gave a speech at a charity event. Asked to talk about his favorite investment idea, he spent 15 minutes explaining why he believe that Allied Capital (NASDAQ: ALD) was a financial crime in progress, ripping off investors and taxpayers as a Small Business Administration lender. Einhorn presented compelling evidence of aggressive accounting and indeed fraud, and disclosed that he was short the stock.

The speech made headlines and the stock tanked. Over the past six years, Einhorn has continued to beat the drum against Allied Capital, presenting information to regulators, reporters, and investors.

39-year old David Einhorn runs a hedge fund with assets under management of $5 billion, but he isn't content with that. Today's Wall Street Journal reports (subscription required) on his new book, Fooling Some of the People All of the Time: A Long Short Story, detailing his public crusade against Allied Capital (NYSE: ALD), which he has accused of fraudulent accounting. Mr. Einhorn is short the stock.

In the book, he also lashes out at the SEC, which has been the target of criticism from fraudsters, fraud-busters, and the anti naked short selling baloney brigade.

Einhorn told the Journal that "The SEC is run by a corporate advocate, not an investor advocate, so investors are getting a false sense of security."

That's a pretty serious criticism, but it seems to be supported by some of the commission's recent actions, including its decision to make it even tougher for investors to hold underperforming directors accountable.

I ordered a copy of the book a few days ago and will post a review as soon as possible.

MOST NOTEWORTHY: Equitable Resources, Allied Capital and Apria Healthcare were today's noteworthy initiations:

• RBC Capital is positive on Equitable Resources' (NYSE:EQT) Appalachian Basin exposure and valuation. Shares were started with an Outperform rating and $78 target.
  
• Morgan Keegan views Allied Capital's (NYSE:ALD) valuation and outlook as attractive, starting shares with an Outperform rating.
  Credit Suisse assumed Apria Healthcare (NYSE:AHG) with a Neutral rating and $20 target, citing the challenging Medicare backdrop.

OTHER INITIATIONS:

• Keefe Bruyette initiated Zions Bancorp (NASDAQ:ZION) with a Market Perform rating and $47 target.
  
• Thomson Reuters (NASDAQ:TRIN) was started with a Sell rating at ABN Amro.
  
• Canaccord Adams initiated Cyberonics (NASDAQ:CYBX) with a Buy rating and $20.50 target.

MOST NOTEWORTHY: Nvidia, Entropic Comm and Cleveland Cliffs were today's noteworthy initiations:

• Piper initiated Nvidia (NASDAQ: NVDA) with a Neutral rating and $23 target and believes the rate at which the company gained market share over the past two years is unsustainable. The firm expects EPS deceleration over the next few years.
  
• Piper believes Entropic Comm (NASDAQ: ENTR) is a key benefactor from the general adoption of high definition video consumer goods, as well as from growth in multi-room DVRs. The firm assumed shares with a Buy rating and $10 target.
  
• Cleveland Cliffs (NYSE: CLF) was started with a Buy rating and $135 target at Deutsche Bank. The firm believes CLF is a leveraged play on bulk commodities' momentum.

OTHER INITIATIONS:

• Merrill initiated Allied Capital (NYSE: ALD) with a Neutral rating.
  
• Stifel initiated Blue Nile (NASDAQ: NILE) with a Buy rating and $54 target, and initiated Bank of Florida (NASDAQ: BOFL) with a Buy rating.

Allied Capital (NYSE: ALD), a business development company engaged in the private equity business, closed at $19.99, a five-year low.

ALD February call option implied volatility is at 58 and puts are at 63, above its 26-week avearge of 29 according to Track Data, suggesting larger risks.

Teva Pharmaceutical (NASDAQ: TEVA), a generic pharmaceutical company, is recently down $1.65 to $48 in pre-open trading.

TEVA announced that George S. Barrett, CEO of TEVA North America, has resigned.

TEVA overall option implied volatility of 25 is near its 26-week average according to Track Data, suggesting non-directional risk.

Options Update is provided by Stock Specialist Paul Foster of theflyonthewall.com

MOST NOTEWORTHY:

Quidel Corp (NASDAQ: QDEL) and Allied Capital Corp. (NYSE: ALD) top today's lengthy initiation list.

• Quidel was initiated with a Buy at C.E. Unterberg. The firm believes Quidel's three main products will drive double digit EPS growth for the next several years.
• Wachovia initiated Allied Capital with an Overweight rating. The firm believes Allied Capital is one of the best positioned finance companies serving the middle market and one of only two public BRD/RIC's that provide investors exposure to both private equity and mezzanine asset classes.

OTHER INITIATIONS:

• Cowen initiated RITA Medical Systems Inc. (NASDAQ: RITA) with an Outperform rating, citing accelerating sales growth from new product ramps for the next three years.
• DreamWorks Animation Inc. (NYSE: DWA) was initiated with an Outperform at Credit Suisse.
• Finally, Ferris Baker Watts initiated Harris & Harris Group Inc. (NASDAQ: TINY) with a Sell, citing valuation.

Initiations summaries provided courtesy of TheFlyOnTheWall.com.