The Securities and Exchange Commission filed a civil suit against Goldman Sachs this morning. According to the SEC, Goldman is guilty of taking a “do what I say, not what I do” approach to mortgaged-backed securities.
Well, d’uh. That’s why Goldman isn’t suckling on the federal teat right now.
The SEC claims Goldman sold a financial instrument that they knew was going to fail, while at the same time taking short positions against that instrument.
Goldman denies the charges:
The SEC’s charges are completely unfounded in law and fact and we will vigorously contest them and defend the firm and its reputation.
Let’s unpack the SEC’s complaint (pdf). Whether or not the SEC prevails in this civil litigation, their complaint certainly succeeds in making Goldman look very shady — the company’s stock tanked this morning.
In January 2007, Goldman put together a financial instrument — ABACUS 2007-AC1 — made up of securities that the SEC claims Goldman knew would tank. Then the firm bet against the instrument. The New York Times reports:
The instrument in the S.E.C. case, called Abacus 2007-AC1, was one of 25 deals that Goldman created so the bank and select clients could bet against the housing market. Those deals, which were the subject of an article in The New York Times in December, initially protected Goldman from losses when the mortgage market disintegrated and later yielded profits for the bank.
As the Abacus deals plunged in value, Goldman and certain hedge funds made money on their negative bets, while the Goldman clients who bought the $10.9 billion in investments lost billions of dollars.
Yes, we get it, nobody likes the guy who plays the “Don’t Pass” line on the craps table. But is it fraud?
Goldman employee Fabrice Tourre was principally responsible for structuring the instrument and is named in the lawsuit. The SEC pulled out some wonderful quotes from “the fabulous Fab”:
At the same time, GS&Co recognized that market conditions were presenting challenges to the successful marketing of CDO transactions backed by mortgage-related securities. For example, portions of an email in French and English sent by 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!!!”
Similarly, an email on February 11, 2007 to Tourre from the head of the GS&Co structured product correlation trading desk stated in part, “the cdo biz is dead we don’t have a lot of time left.”
Oh Tourre (no relation to that MSNBC guy, Touré), giving voice to thought is never good when you are fleecing the masses….
The other shady thing the SEC alleges is that the person who picked many of the securities, John Paulson (no relation to former Goldman head and Treasury Secretary Hank Paulson), intended to short the funds. The SEC alleges he purposefully picked shaky securities.
Which I suppose would have been perfectly fine had Goldman simply told investors that the portfolio was a piece of crap. But where’s the fun in that? The complaint alleges that Tourre and Goldman represented to investors that ACA Management had picked the portfolio, when in reality it was Paulson picking:
On February 2, 2007, Paulson, Tourre and ACA met at ACA’s offices in New York City to discuss the reference portfolio. Unbeknownst to ACA at the time, Paulson intended to effectively short the RMBS portfolio it helped select by entering into CDS with GS&Co to buy protection on specific layers of the synthetic CDO’s capital structure. Tourre and GS&Co, of course, were fully aware that Paulson’s economic interests with respect to the quality of the reference portfolio were directly adverse to CDO investors. During the meeting, Tourre sent an email to another GS&Co employee stating, “I am at this aca paulson meeting, this is surreal.” …
On February 5, 2007, an internal ACA email asked, “Attached is the revised portfolio that Paulson would like us to commit to – all names are at the Baa2 level. The final portfolio will have between 80 and these 92 names. Are ‘we’ ok to say yes on this portfolio?” The response was, “Looks good to me. Did [Paulson] give a reason why they kicked out all the Wells [Fargo] deals?” Wells Fargo was generally perceived as one of the higher-quality subprime loan originators.
You know the rest of the story. This was 2007. Investors bought, the market tanked, Goldman came out alright.
If even some of this complaint is true, it seems like Goldman and Tourre were up to some shady business.
But you didn’t think some institutions escaped the greatest market collapse since the Great Depression just by being smarter than everyone else, did you?
SEC v. Goldman Sachs (pdf) [via Dealbreaker]
SEC Charges Goldman Sachs With Fraud On Subprime Mortgages [Dealbreaker]
BREAKING: SEC Charges Goldman Sachs With Fraud [Am Law Daily]
U.S. Accuses Goldman Sachs of Fraud in Mortgage Deals [New York Times]