GOLDMAN SACHS ACCUSED OF CIVIL FRAUD BY SEC
Big development for the financials and the White House crackdown on the banks:
Washington, D.C., April 16, 2010 — The Securities and Exchange Commission today charged Goldman, Sachs & Co. and one of its vice presidents for defrauding investors by misstating and omitting key facts about a financial product tied to subprime mortgages as the U.S. housing market was beginning to falter.
The SEC alleges that Goldman Sachs structured and marketed a synthetic collateralized debt obligation (CDO) that hinged on the performance of subprime residential mortgage-backed securities (RMBS). Goldman Sachs failed to disclose to investors vital information about the CDO, in particular the role that a major hedge fund played in the portfolio selection process and the fact that the hedge fund had taken a short position against the CDO.
“The product was new and complex but the deception and conflicts are old and simple,” said Robert Khuzami, Director of the Division of Enforcement. “Goldman wrongly permitted a client that was betting against the mortgage market to heavily influence which mortgage securities to include in an investment portfolio, while telling other investors that the securities were selected by an independent, objective third party.”
Kenneth Lench, Chief of the SEC’s Structured and New Products Unit, added, “The SEC continues to investigate the practices of investment banks and others involved in the securitization of complex financial products tied to the U.S. housing market as it was beginning to show signs of distress.”
The SEC alleges that one of the world’s largest hedge funds, Paulson & Co., paid Goldman Sachs to structure a transaction in which Paulson & Co. could take short positions against mortgage securities chosen by Paulson & Co. based on a belief that the securities would experience credit events.
According to the SEC’s complaint, filed in U.S. District Court for the Southern District of New York, the marketing materials for the CDO known as ABACUS 2007-AC1 (ABACUS) all represented that the RMBS portfolio underlying the CDO was selected by ACA Management LLC (ACA), a third party with expertise in analyzing credit risk in RMBS. The SEC alleges that undisclosed in the marketing materials and unbeknownst to investors, the Paulson & Co. hedge fund, which was poised to benefit if the RMBS defaulted, played a significant role in selecting which RMBS should make up the portfolio.
The SEC’s complaint alleges that after participating in the portfolio selection, Paulson & Co. effectively shorted the RMBS portfolio it helped select by entering into credit default swaps (CDS) with Goldman Sachs to buy protection on specific layers of the ABACUS capital structure. Given that financial short interest, Paulson & Co. had an economic incentive to select RMBS that it expected to experience credit events in the near future. Goldman Sachs did not disclose Paulson & Co.’s short position or its role in the collateral selection process in the term sheet, flip book, offering memorandum, or other marketing materials provided to investors.
The SEC alleges that Goldman Sachs Vice President Fabrice Tourre was principally responsible for ABACUS 2007-AC1. Tourre structured the transaction, prepared the marketing materials, and communicated directly with investors. Tourre allegedly knew of Paulson & Co.’s undisclosed short interest and role in the collateral selection process. In addition, he misled ACA into believing that Paulson & Co. invested approximately $200 million in the equity of ABACUS, indicating that Paulson & Co.’s interests in the collateral selection process were closely aligned with ACA’s interests. In reality, however, their interests were sharply conflicting.
According to the SEC’s complaint, the deal closed on April 26, 2007, and Paulson & Co. paid Goldman Sachs approximately $15 million for structuring and marketing ABACUS. By Oct. 24, 2007, 83 percent of the RMBS in the ABACUS portfolio had been downgraded and 17 percent were on negative watch. By Jan. 29, 2008, 99 percent of the portfolio had been downgraded.
Investors in the liabilities of ABACUS are alleged to have lost more than $1 billion.
The SEC’s complaint charges Goldman Sachs and Tourre with violations of Section 17(a) of the Securities Act of 1933, Section 10(b) of the Securities Exchange Act of 1934, and Exchange Act Rule 10b-5. The Commission seeks injunctive relief, disgorgement of profits, prejudgment interest, and financial penalties.
Poor Chris with his “leveraged” & “maxed out” bank trade.
This is a vomit inducing lawsuit. Anyone who has ever doubted my comments about the banks need look no further than these emails at Goldman. They’re sickening.
Here comes the regulatory overhaul!
This is really just bad luck for Chris. But he was being greedy in my opinion. Hopefully he wasn’t too leveraged.
i told you i wasn’t greedy.
Sincerely, I hope you didn’t get dinged too badly….I know we don’t always agree, but I don’t wish losses on any other investor.
Except maybe Goldman Sachs
danish, thanks for the concern, you will remember that i am a day trader, as you called me, because i use tight stops. well, today is the kind of day i am thankful for tight stops. still a little down today, overall, which i am not used to, so i took advantage by buying some calls marked down.
a couple of points to make here.
this is not a slam dunk case by the sec. this is a highly technical false and misleading case involving very sophisticated counterparties. on this alone, the sec has an uphill climb, although if there are some very bad recorded statements or emails (don’t know, haven’t read the complaint), then maybe they can make the allegations stick.
second, the sec gets to make goldman disgourge its fee from the deal…$15MM. maybe get an agreement not to do it again.
so the market’s reaction is that where there is smoke there is fire. yet, these facts are rather one off, involving an isolated vp at goldman (low on the totem pole) and his good client paulson & co.
it is not clear to me that the sec could replicate this case across the subprime cdo spectrum, which the market seems to believe. also, i don’t see this rather arcane f&m case being the premise for a criminal referral, which the market also seems to believe is possible.
so now is your chance to buy financials if you thought they were too expensive before, imho.
You are so full of shit. “Tight stops”. Hahaha.
Easy Dan. Even with today’s losses Chris is likely still up.
You don’t think this is a slam dunk? Have you read the emails? It’s plain as day.
I wouldn’t touch the banks here. The public will demand regulatory overhaul now. The Volcker Rule is back on the table.
i have not read the emails.
do not underestimated what a good defense lawyer can accomplish in a highly technical case…but again, this is a $15MM case, with the ramifications being anywhere from a big shrug to, as you say, the volcker rule. i find that people tend to overestimate the impact of news, both on the upside and downside.
as for my portfolio, i am down less than 10% from my highwater mark. i would tell you what my gain is over the last 16 months, but types like danish would only respond with invective and embarrass themselves with their choice of language again.
you’re down almost 10% today? Wow. nice risk management there.
Maybe the goldman boys will have to cut back on their yachts, prostitutes and cocaine binges.
Doubt it though.
Any idea why Paulson & Co weren’t named in the suit? Is it because Goldman was the dealer?
paulson made no representations in the selling docs. this is an f&m case.
Yeah, Chris is right. They made no representations though I am having trouble seeing as how this wasn’t insider trading. They helped advise in structuring the deal where the SEC alleges it was not accurately disclosed and then Paulson makes BILLIONS betting against it?
Something doesn’t smell right here.
paulson owed no duty to the buyer; hence, no basis for fraud. i know a little about securities law.
the fascinating thing to speculate on is the conversation the sec had with lloyd et al before they filed this case.
you could see goldman assessing the risks and saying let’s throw the vp under the bus, enter into a consent decree without admitting guilt, and fight any private party tooth and nail in any subsequent private action…most firms would do that.
goldman is nothing but a savvy risk taker, and i think they think they can win this case…otherwise, it doesn’t make much sense not to have nipped this in the bud at a cost of $15MM and a toothless consent decree.
there is always the chance the sec didn’t proffer before filing, but that has not been their typical MO.
SEC sent them a Wells notice, previously, I believe.
Also, read the SEC complaint — top rhs, about Jury Trial Demanded — that’s relatively unusual (I believe) and given the populist outrage, a jury trial is more likely to convict.
It’s also a brilliant political move; the charges are regarding the disclosure docs (not the fact that they were doing it)…Main Street can immediately see that’s wrong, and it’s not a complicated argument. It’s an Al Capone move, get someone on something tangential and see what shakes out…
Makes passing bank reform easier — back bank reform or support GS (who appear in the wrong)
TPC
Do you have the links to the emails that you are referring to?
http://www.sec.gov/litigation/complaints/2010/comp-pr2010-59.pdf
Anyone notice the major strength in the mortgage insurers (PMI, MTG, RDN)and financial guarantors (MBI, ABK) the last couple weeks.
Get ready for major large bank blow back as these insurers deny claims and sue for past paid claims based on fraudulent activity at the banks, rating agencies, etc.
I’d stay away from the banks and take a closer looks at the insurance cos.
now that is an interesting thought…and a very hard case to win.
I agree with chris, this is a case which will go nowhere. GS and Paulson just took advantage of idiot investors who blindly wanted to go long CDO tranches relying on ratings and making an “arbitrage”! If BB corporates were priced at L + 200, then why not get the “same credit” exposure by selling protection on the exactky similarly rated BB CDO tranche at L + 350…hallelujah! 150bps of free arbitrage money.
This case will go nowhere. As to the e-mails, ha, if I could sell garbage to someone (who is or at least is supposed to be and represents that he is) a sophisticated investor and get away with it, I would do it all day long.
Rating agencies are the sole culprits in this. They assigned a rating that was nowhere near what it should have been and dumb “sophisticated” (yes, I know that is an oxymoron!) investors bought them hand over fist. Heck, I still see the same “sophisticated” investors today relying almost solely on ratings and lapping up credit products.
All that said, chris is too smug with his “profits”. Good trade (I did that too, but sold out too soon! My mistake), but no reason to believe that these are anywhere near sustainable. With free money (JPM got paid 5bps this past quarter to borrow!) and a steep yield curve, any monkey of a bank can make money. What is surprising to me is that the market thinks that everythign has been somehow “fixed” with the banks and that they are screaming buys….that will also end badly.
haris, i am in for so long as big ben is in.
i don’t mean to be smug but there is a lot of pushback on this site and noway nohow do i back down when i think i am right.
i think the sec is going to have a long run for a short slide on this case. will read docs over the weekend to see for sure.
I’d say any time you lose almost 10% in one day you’ve already been proven wrong. You got greedy and leveraged up a position at the market peak. You know a lot less than you like.
You guys should just steel cage this and get it over with.
In my opinion, I think you guys have it wrong. It doesn’t matter that they were able to trade this thing off to someone else. It’s that they put it together at all. This is no different than a fraudulent company who goes public and effectively defrauds shareholders by selling a prospectus that implies it is investment grade or in healthy financial condition when it is far from that. Will people buy the IPO? Sure, they will. Especially if GS underwrites it. Why? Because GS is supposed to be a trustworthy firm that would never take a fraudulent company public.
They effectively did that here. They prepackaged a mortgage portfolio that their client KNEW was worthless, they got paid $15MM for it and they marketed it to some schmuck. I am not protecting the schmucks here, but GS should have never marketed this piece to begin with. Paulson knew it was a POS and the underwriters at GS knew as well.
This case is pretty cut and dry in my opinion. This line that the client bought it so they got taken to the bank is BS. It doesn’t change the fact that Goldman knowingly marketed a piece of paper that was nothing like their offering said it was….
But legally are they required to disclose that Paulson was an investor? I don’t think they are that and that’s the basis of the case. Was it a slimy transaction that makes GS look terrible? Yes. But I don’t know if you can find them liable for marketing the deal. This one will be hard to prove, but that’s not the point here. The point is the get the public all riled up so we jam fin reg thru. GS loses either way.
Well, the big problem is that Paulson hand picked the original (I think 92 is right) securities and then ACA narrowed it down. I’d have to re-read the PR, but I think that’s right.
They might not be required to disclose who is on the other side of the trade, but this was a unique transaction in that Paulson went to them, offered them $15MM in fees and then they sold the thing as though Paulson wasn’t on the other side of it. That seems pretty cut and dry to me. Will it be hard to win? Probably, but as you said, I don’t think the SEC is even trying to win this anyway. They want fin reg passed NOW.
Obama is whipping out another big bill. This one I am in favor of. He can jam this one right down the banker’s throats for all I care. He said he’d veto any bill without derivatives reform. That alone is billions in commissions these firms make….
I think you have to be totally nuts to buy the banks in the next month. Not until the dust settles on this one. The reaction to GS might be extreme, but the others can’t be touched. A pairs trade with a GS long might not be a bad move….
Timmy G:”SEC boneheads, I told you to wait until I sold **my warrants** and C common. Don’t you have any ex-Goldman guys at the SEC there who know anything about juicing/squeezing the market? Idiots.”
Another scam by GS and their pawns in D.C.
The GS e-mail was written in January 2007, a full year AFTER the housing bubble had already burst. The stock market crash however was still another ten months away .
krut, embarrassing emails out of context have nothing to do with winning a case, but everything to do with political gamesmanship…the sec has bought itself a huge fight
You guys are all missing the point if you’re worried about whether GS will win or not. This is all for political show. They’re using this to game fin reg. This will take forever to go to trial and by the time it does the Obama administration will have already slammed fin reg through. You’re insane to buy financial stocks between now and clarification on what happens with regulation.
The public is 99% backing Obama on regulation now after this news. The banks will suffer for the next few weeks until there is clarification about this.
I think you’re right Dan. This is a sideshow. The debate over fin reg will rule the next few weeks and this was just one political maneuver to help pass a strong reform bill.