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Friday, April 16, 2010

Goldman Sachs Charged with Fraud

The SEC charges Goldman Sachs with fraud related to marketing sub-prime securities.

SEC Charges Goldman Sachs With Fraud in Structuring and Marketing of CDO Tied to Subprime Mortgages -- 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 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...


COMPLAINT [Securities Fraud] -- Jury Trial Demanded

Plaintiff, the United States Securities and Exchange Commission ("Commission"), alleges as follows against the defendants named above:
1. The Commission brings this securities fraud action against Goldman, Sachs & Co. (“GS&Co”) and a GS&Co employee, Fabrice Tourre (“Tourre”), for making materially misleading statements and omissions in connection with a synthetic collateralized debt obligation (“CDO”) GS&Co structured and marketed to investors. This synthetic CDO, ABACUS 2007AC1, was tied to the performance of subprime residential mortgage-backed securities (“RMBS”) and was structured and marketed by GS&Co in early 2007 when the United States housing market and related securities were beginning to show signs of distress. Synthetic CDOs like ABACUS 2007-AC1 contributed to the recent financial crisis by magnifying losses associated with the downturn in the United States housing market.

2. GS&Co marketing materials for ABACUS 2007-AC1 – including the term sheet, flip book and offering memorandum for the CDO – all represented that the reference portfolio of RMBS underlying the CDO was selected by ACA Management LLC (“ACA”), a third-party with experience analyzing credit risk in RMBS. Undisclosed in the marketing materials and unbeknownst to investors, a large hedge fund, Paulson & Co. Inc. (“Paulson”), with economic interests directly adverse to investors in the ABACUS 2007-AC1 CDO, played a significant role in the portfolio selection process. After participating in the selection of the reference portfolio, Paulson effectively shorted the RMBS portfolio it helped select by entering into credit default swaps (“CDS”) with GS&Co to buy protection on specific layers of the ABACUS 2007-AC1 capital structure. Given its financial short interest, Paulson had an economic incentive to choose RMBS that it expected to experience credit events in the near future. GS&Co did not disclose Paulson’s adverse economic interests or its role in the portfolio selection process in the term sheet, flip book, offering memorandum or other marketing materials provided to investors.

3. In sum, GS&Co arranged a transaction at Paulson’s request in which Paulson heavily influenced the selection of the portfolio to suit its economic interests, but failed to disclose to investors, as part of the description of the portfolio selection process contained in the marketing materials used to promote the transaction, Paulson’s role in the portfolio selection process or its adverse economic interests.

4. Tourre was principally responsible for ABACUS 2007-AC1. Tourre devised the transaction, prepared the marketing materials and communicated directly with investors. Tourre knew of Paulson’s undisclosed short interest and its role in the collateral selection process. Tourre also misled ACA into believing that Paulson invested approximately $200 million in the equity of ABACUS 2007-AC1 (a long position) and, accordingly, that Paulson’s interests in the collateral section process were aligned with ACA’s when in reality Paulson’s interests were sharply conflicting.

5. The deal closed on April 26, 2007. Paulson paid GS&Co approximately $15 million for structuring and marketing ABACUS 2007-AC1. By October 24, 2007, 83% of the RMBS in the ABACUS 2007-AC1 portfolio had been downgraded and 17% were on negative watch. By January 29, 2008, 99% of the portfolio had been downgraded. As a result, investors in the ABACUS 2007-AC1 CDO lost over $1 billion. Paulson’s opposite CDS positions yielded a profit of approximately $1 billion for Paulson.

6.  By engaging in the misconduct described herein, GS&Co and Tourre directly or indirectly engaged in transactions, acts, practices and a course of business that violated Section 17(a) of the Securities Act of 1933, 15 U.S.C. §77q(a) ("the Securities Act"), Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. §78j(b) ("the Exchange Act") and Exchange Act Rule 10b-5, 17 C.F.R. §240.10b-5. The Commission seeks injunctive relief, disgorgement of profits, prejudgment interest, civil penalties and other appropriate and necessary equitable relief from both defendants. [...]

For example, portions of an email in French and English sent by Fabrice Tourre to a friend on January 23, 2007 stated, in English translation where applicable:
“More and more leverage in the system, The whole building is about to collapse anytime now…Only potential survivor, the fabulous Fab[rice Tourre]…standing in the middle of all these complex, highly leveraged, exotic trades he created without necessarily understanding all of the implications of those monstruosities!!!”
Infectious Greed:
Blast from the Goldman Testimony Past: CDOs and Bad Brakes
Top CDO Underwriters, 2002-2007

Kevin Depew / Minyanville:
Worth noting that the SEC has apparently only used the word "fraud" in a filing three times in the past 10 years: Worldcom, Enron and now today.
David Goldman / Inner Workings:
Pandora’s Box is Open and Woe to the Financials -- This opens Pandora’s Box. Investors who lost a trillion dollars in subprime CDO’s now will descend like Harpies upon the banks that packaged them, with subpoenas for every email and internal memorandum involved. The civil suits that could arise from this are potentially innumerable...

The ProPublica Blog: Other Major Banks Did Deals Similar to Goldman’s
Deal Journal / WSJ.com: SEC v. Goldman: ‘The Fabulous Fab[rice Tourre]‘
Fawn Johnson / Wall Street Journal:   Goldman Is Charged With Subprime Fraud
The Big Picture: SEC Sues Goldman Sachs

New York Times:
U.S. Accuses Goldman Sachs of Fraud  — Goldman Sachs, which emerged relatively unscathed from the financial crisis, was accused of securities fraud in a civil suit filed Friday by the Securities and Exchange Commission, which claims the bank created and sold a mortgage investment that was secretly devised to fail...

more discussion:

NY Times (Dec 2009):
Banks Bundled Bad Debt, Bet Against It and Won - Mr. Egol and Fabrice Tourre, a French trader at Goldman, were aggressive from the start in trying to make the assets in Abacus deals look better than they were, according to notes taken by a Wall Street investor during a phone call with Mr. Tourre and another Goldman employee in May 2005...
The other Goldman incident.

Susan Pulliam / Wall Street Journal:
Goldman Director to Leave -- Rajat Guptatold Goldman Sachs Group Inc. in March he wouldn't stand for re-election as a director, after receiving notice from prosecutors that they were reviewing recorded conversations between him and Galleon Group founder Raj Rajaratnam, people close to the matter say.

Mr. Gupta, a Goldman director since 2006, said through a spokesman that his decision to step down was because of "other commitments."

The U.S. has charged Mr. Rajaratnam and 20 others in a wide-ranging insider-trading case. Mr. Rajaratnam is fighting the charges; 11 others have pleaded guilty in the case, which is continuing...

Goldman's new $2.1 billion HQ

Goldman Sachs's New Palace Creates Princes, Serfs -- Goldman Sachs Group Inc.'s new headquarters in lower Manhattan has the kind of amenities befitting masters of Wall Street. The $2.1 billion steel-and-glass building has giant murals, opera-house ceiling heights, and a gym with overachiever fitness classes, like "Awesome Abs."

But a new class of haves and have-nots has emerged—even at Goldman where the notion of have-nots is relative. Outside offices are now reserved only for the firm's more than 300 elite partners. Managing directors, next down in the Goldman hierarchy, almost always get windowless inside offices...

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