In May 2002, the financial markets were mired in a grinding downturn, which is to say it was a great time to be a hedge fund manager. After the insanity of the dotcom era, company profits and balance sheets finally mattered again. Skeptics felt confident in taking their cases public. It was in this environment that David Einhorn, a lanky and boyish 39-year-old who heads the $6 billion firm Greenlight Capital, spoke to a charity investing conference.

His topic that day was the Washington, D.C., finance company Allied Capital, a lender to and investor in midsize companies. Einhorn methodically went after Allied, claiming that it had inflated its assets and overstated its worth and profitability. While Einhorn has developed a reputation for witty and incisive speeches, they tend to read better than they sound. After the speech, he received a smattering of compliments and went home. He figured that reality would eventually catch up with the stock, and he would move on to other investments.

He was wrong. The next day, Allied stock tumbled nearly 20 percent as word of Einhorn’s critique spread, setting in motion one of the nastiest Wall Street wars in recent memory. Over the next several years, Einhorn would learn firsthand what happens to people who question the accepted rules of engagement on Wall Street. His saga is part detective story, part cautionary tale, part master class in investing, and a case study in what’s wrong with regulators, Wall Street, and the financial media (including me, as I play a small role). “The steep decline was nothing compared to the plunge I was about to take, spending years uncovering what I view as a fathomless fraud,” Einhorn writes in his new book about the battle, Fooling Some of the People All of the Time.

More important, Einhorn’s experience illuminates our current crisis. Throughout the subprime mess, critics who questioned runaway credit or the way Wall Street marketed credit derivatives were dismissed as overly pessimistic. Regulators who could have headed off the problem took too long to act. Six years on, some of Einhorn’s allegations against Allied have been proved right. Yet Allied’s managers have stayed in their jobs, reaping millions of dollars in compensation. And Einhorn has had to spend time and money deflecting accusations that he was a dirty short-seller with an ax to grind, smearing Allied for profit.

Einhorn’s initial claim in the speech will sound familiar to anyone who has watched Wall Street’s swoon during the past year. He argued that the company kept hard-to-price illiquid investments at inflated values on its books. He would subsequently discover that a major Allied portfolio company, a small-business lender called Business Loan Express, had made all sorts of bad loans to dodgy customers—to the tune of tens of millions of dollars in losses.

Einhorn and others brought Allied’s issues to the attention of regulators and law enforcement agencies, who either weren’t up to the task of taking on the company or whose sanctions came too late. So when Bear Stearns collapsed because of its own foolish risk-taking, blaming shadowy rumors for its demise, and the Securities and Exchange Commission started a witch hunt to investigate those “rumormongers,” who could have been surprised?

THE SIX YEARS’ WAR

After Einhorn’s speech that May, Allied mounted a counteroffensive. Company executives organized a conference call to refute his contentions. And they attacked Einhorn’s motives, since he was, by his own admission, shorting Allied stock.

The Wall Street machinery kicked in to defend Allied. Merrill Lynch, Allied’s main banker, backed up the company, even to the point of misstating an accounting rule to justify the company’s bookkeeping. (Merrill declined to comment.) When Mark Alpert, a Deutsche Bank analyst, issued a rare “sell” rating on Allied, the New York Stock Exchange investigated his report. A few months later, Alpert left the bank, and a few months after that, Deutsche Bank underwrote the first of at least five Allied stock offerings.

Einhorn was investigated by the S.E.C., and documents related to his Allied speech and positions were subpoenaed. (Then-New York attorney general Eliot Spitzer’s office also looked into Einhorn’s activities but took no action.) One of the S.E.C.’s lawyers eventually left and registered as an Allied lobbyist. Through pretexting—pretending to be someone else—an Allied investigator went on to snatch Einhorn’s phone records, a case that generated much less attention than a similar breach at ­Hewlett-Packard that involved pretext­ing journalists. (Allied eventually admitted to having the records but denied authorizing pretexting.)

For years, the financial media, if it covered the story at all, wrote only obligatory pieces, without delving into details. I’m no exception; Einhorn approached me early on with some material about the company. But it was complicated, and Allied aggressively refuted the allegations, so I backed off. Though I would later take critical looks at Allied, I wish I had initially persevered.

Eventually, the S.E.C. turned away from investigating Einhorn and started to look into the company. The agency ultimately sanctioned Allied for failing to preserve documents supporting its valuations between 2001 and 2003. Allied received no fines or penalties. The S.E.C. woefully, I think, pulled its punches. Other investigators, including the Department of Justice, found a pattern of fraudulent lending, indicting an employee of Business Loan Express. (He pleaded guilty.) The office of the inspector general of the Small Business Administration criticized the agency’s handling of BLX. Belatedly, the S.B.A. effectively put Allied out of the government-backed-loan business.

WAS IT WORTH IT?

Greenlight’s New York offices reflect Einhorn’s finance-geek personality. The conference rooms are named after accounting gimmicks: The Nonrecurring Room, for example, references some companies’ practice of taking gains that have nothing to do with their ongoing business.

In addition to managing money, Einhorn serves on a couple of prominent charity boards and has played in the World Series of Poker, grabbing a moment in the limelight in 2006 when he came in 18th out of 8,773 participants in the main event. He donated his winnings, $659,730, to the Michael J. Fox Foundation for Parkinson’s Research.

Einhorn lives for investing and, so far, has resisted the requisite lavish lifestyle. He has one house, outside New York City. He has no jet, no hockey rink with its own Zamboni, no Jeff Koons balloon sculptures hanging next to Ed Ruschas, and no Hamptons estate. I wondered if Einhorn thought that going public with his Allied fight was a mistake. “It shouldn’t be,” he says. “If it is, that’s a bad outcome. It’s a bad conclusion if people can’t talk critically about stocks.”

Einhorn picks his words carefully. “Allied is, in a sense, boring,” he says. “Boring isn’t the right word. I view it as a”—he pauses—“garden-variety fraud, not extraordinary. I have dealt with some extraordinary frauds, but they didn’t make for this story.”

What’s important about this story, he says, is that “the whole system failed”—and is in the process of failing again. “I’m really trying to make bigger points about free speech, free markets, the regulatory environment, and the way Wall Street works.”

Whenever a short-seller criticizes a company, the firm and the media go out of their way to disclose that the critic stands to gain financially. This is proper. Often, however, the disclosure serves to undermine the messenger and distract from the issues. In his book, Einhorn makes the crucial and often neglected point that short-sellers usually have far less incentive to fudge facts than management: “For Greenlight, Allied is one of many ways for us to make money.... For management, Allied is the whole ball of wax. If Allied is shown to be fraudulent, the consequences would be much more dire than losing a few dollars. Top management players could lose their jobs and possibly go to jail.”

Allied is still on the defensive. “The book appears to be nothing but a self-serving rehash of the same discredited charges that Mr. Einhorn has made for the past six years,” a spokesperson said. “The reality is that the third parties that have examined his charges against Allied and Allied’s responses to them—the courts, the S.E.C., leaders in the capital markets, and the investing public—have made it patently clear that his premise that he is right and the whole world is wrong is absurd.”

Honest companies tend to let business take care of itself. “Six years ago, I told the S.E.C. about Allied’s aggressive, inappropriate, and illegal accounting. Five years ago, I told multiple government agencies about the fraud. Four years ago, I told the F.B.I. that other Allied critics and I had our phone records stolen. Three years ago, I notified Allied’s board in detail about its management’s misconduct and made a detailed presentation to the U.S. Attorney in Washington outlining a variety of illegal activities,” Einhorn writes.

And Einhorn has the resources to keep talking about Allied. Typical whistleblowers don’t. He was a critic with time, money, and power on his side. And yet in many ways, he still lost.