

SEC Charges Goldman Sachs With Fraud - ra88it
http://www.sec.gov/news/press/2010/2010-59.htm

======
AmericanOP
To discourage misinformation, here's a copied and pasted summary for those who
aren't going to read the whole thing:

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.

~~~
flipbrad
It's not clear to me what this is - Paulson facing corruption charges, Goldman
facing breach of fiduciary duty/conflict of interest, or Goldman and Paulson
facing conspiracy to defraud?

~~~
MaysonL
Eventually all of the above, if we're lucky. Right now, just GS lying to
investors.

------
robdimarco
These are the civil charges, it will be interesting to see if there are
criminal charges. A civil verdict against GS just costs money. A felony
conviction would destroy the bank, like it did to Arthur Andersen.

~~~
gcv
The Times article says that the SEC has been investigating those deals for
months. Has this been in the news and I just missed it?

------
rjett
Goldman's activity sounds a lot like the trade that UBS, Merrill, Citi, and 6
other IBs helped Magnetar perform. [http://www.propublica.org/feature/all-the-
magnetar-trade-how...](http://www.propublica.org/feature/all-the-magnetar-
trade-how-one-hedge-fund-helped-keep-the-housing-bubble)

~~~
jamiequint
The difference is that these were synthetic CDOs so they didn't generate more
demand for residential mortgage backed securities, rather they piggybacked off
pre-existing ones. This likely did nothing to expand the bubble.

~~~
btilly
They didn't directly generate more demand, but the existence of deals like
this generated a market for the low quality bonds in deals, which made the
hardest part of structuring those deals much easier.

So no, it didn't directly expand the bubble. But this kind of activity
indirectly did so. (Though this particular deal came late enough that the
bubble was about to collapse anyways.)

~~~
jamiequint
I'm not sure this is true. If the packagers of the non-synthetic CDOs realized
no benefit from Synthetic CDOs being made off of theirs why would they have
incentive to cater to the Synthetic CDO creators.

~~~
btilly
The market for synthetic CDOs like this only arose because the demand for low
quality debt exceeded the available supply. Evidence that demand exceeds
supply is encouragement to create more low quality debt.

So no, it is not a direct connection. But it is indirect encouragement.

------
dsplittgerber
Doesn't anyone else think this is a just a short-term measure to appease
public opinion? It was obvious something like this had to happen, there is
still a lot of blame to be attributed. Alas, it's the easy way out. Of course,
some of the things that happened have to be brought to court, as there
definitely was at least misrepresentation, if not fraud, involved.

That doesn't change the fact that there are much larger things amiss.

1\. Regulators who are ill-suited and ill-willing to enforce existing
standards, not to mention any kind of additional authority that gets bestowed
on them soon. There are numerous cases of whistles rightly being blown where
regulators didn't do anything. Selective enforcement is worse than no
enforcement at all.

2\. Too much governmental interference in markets and backstopping of market
actors to let markets function properly - but blame it all on the markets
afterwards and cover up all kinds of fraud at Fannie/Freddie. This encourages
fraud in markets which the government kindly looks down upon (it's housing,
after all)

3\. No consistent policy regarding bail-outs. If you bail-out market actors,
you have to split up 'too big to fail'-institutions; otherwise it's just a
game of waiting for the next tax-payer-sponsored bail-out.

~~~
cwp
No, it doesn't solve all the deep-seated problems in our financial/political
system. But it's still good news, because:

\- Court cases tend to make public previously secret information. Witness the
recent publicity of banks under-reporting their debt levels. That pretty much
came out of the Lehman bankruptcy proceedings. Lehman's accounting tricks came
out in court, and people started wondering if other banks were still doing it.

\- It keeps the issue in the spotlight so that politicians feel pressure to do
something about it. Perhaps this will help strengthen the Senate's reform
bill.

\- The SEC is finally doing its job again! It's a small step, yes, but it's a
start. Go Schapiro!

------
manderson2080
This whole problem had two starting points.

1\. The repeal of the Glass-Steagal act. This allowed banks to undertake the
business of commercial banks, investment banks, and insurance agencies. That
means that, banks were able to build these complex derivatives, use money from
people's savings accounts to partake in risky investments, and then insure
them with high standards. All from under one roof.

2\. The investment firms went public. This was a fundamental change in the
80's where Goldman, Morgan Stanley, and many others where they became
officially owned by the public. That ment that the risk of all their losses
was owned by the shareholders as well as profits. Risky investing became the
norm, because if you lost a ton of money for Goldman, you may have gotten
chewed out or lost your job. But if you made a ton of money for Goldman, you
had a very large bonus waiting for you.

Now this mindset has just grown out of hand. It's greed that is driving our
financial center, Wall Street.

~~~
aaronbrethorst
Also known as the Gramm-Leach-Bliley Act.
<http://en.wikipedia.org/wiki/Gramm–Leach–Bliley_Act>

That Gramm guy is Phil Gramm, who later went on to say that the recession was
all in our head's and that we're a nation of whiners.
[http://www.huffingtonpost.com/2008/07/10/mccain-adviser-
amer...](http://www.huffingtonpost.com/2008/07/10/mccain-adviser-
americans_n_111857.html)

He also happened to be McCain's chief economic advisor and a co-chair of
McCain's national campaign during the 2008 Presidential campaign.
[http://money.cnn.com/2008/02/18/news/newsmakers/tully_gramm....](http://money.cnn.com/2008/02/18/news/newsmakers/tully_gramm.fortune/index.htm?postversion=2008021917)

Too bad we elected a socialist to the White House. Think how much better we'd
be off with McCain and Palin right now! Goldman Sachs would be just fine! The
economy would be great! Phil Gramm would be vindicated!

Or we'd be living in the economic equivalent of the Weimar Republic right now.
Yeah, that's probably more likely.

------
claymmm
This is exactly like an arsonist burning down a building to collect insurance.
It's plain old fraud.

~~~
billybob
Upvoted. But there's a difference - the arsonist is only allowed to get an
insurance policy on buildings he owns.

It's more like an arsonist taking out insurance policies on other people's
buildings, THEN burning them down.

Except we don't allow crazy antics like that with insurance. And the insurance
companies have to keep money reserved to pay out claims. And it has to go on
their balance books.

So what we have here is "a building just burned! Oh crap, who has insurance on
that? Who sold it? Who's going to go broke? Who shouldn't we lend money to?
Nobody knows!"

~~~
lkijuhyghjm
It's more like a doctor being able to take out a $M life insurance policy on a
patient before he operates!

~~~
warfangle
Or, while we're on the analogy train, a doctor taking out a $MM life insurance
policy on a terminal patient before he performs an operation (which will in no
way help the patient live longer), collecting the patient's health insurance
dollars along the way.

------
johnohara
I've always viewed CDO's as being similar to "pointer-based" securities. GS
sold the value of the pointer rather than the value of the data at the
location.

Like any memory crash, when the value at the location is wiped out, any
pointer to it is useless.

Shorting the value of the pointer makes sense when you know ahead of time that
the value at the location will soon be clobbered.

------
rrhyne
I doubt this is going anywhere.

The suit is civil, not criminal which likely means no one is going to jail.
They'll get find 1% of what they made on the deal and call it the cost of
doing business.

~~~
MaysonL
No one is going to jail. _Yet._

------
prosa
I particularly enjoyed this quote from Tourre (the named VP defendant),
talking about how they have to move fast:

 _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!!!_

Fabulous Fab indeed!

------
otakucode
Will they have the guts to fine Goldman even one millionth of the amount they
earned through the fraud? I seriously doubt it. For all intents and purposes,
Goldman Sachs IS the United States economy.

------
va_coder
Goldman is so powerful. I'm shocked the SEC is brave enough to do this.

~~~
siavosh
Let's not count the chickens before they hatch. The SEC is known for filing
highly public cases just to get pressure off their a __. This case might very
well be discarded 6mo down the line and be reported in a footnote in the last
page of the WSJ business section.

~~~
va_coder
Yea..the unfortunate and unjust reality sets in

------
signa11
this is pretty instructive:

CARY LEAHEY, SENIOR MANAGING DIRECTOR, DECISION ECONOMICS, NEW YORK:

"The SEC has come out swinging, going after the biggest, most recognized name
on Wall Street with regard to alleged abuses in the credit derivatives market.
This will be a difficult case to prove, particularly to the laymen on the
jury, as even supposed experts on Wall Street with years of experience in this
area are still scratching their heads trying to figure out who did what to
whom and when."

~~~
ajg1977
1) Create hand-picked collections of assets a favored investor wants to bet
large sums against.

2) Sell those packages as investments to other clients, with clear statements
that they were chosen by independent parties.

Doesn't sound too difficult to prove to me.

~~~
iron_ball
It's easy to phrase it that way, hard to prove (to a legally sufficient
degree) that that phrasing is correct.

~~~
MaysonL
Hard to prove beyond a reasonable doubt, maybe. But this is a civil case, and
I believe the standard is merely by a preponderance of the evidence.

------
anigbrowl
Rabobank (NL) has an active civil suit against Merill Lynch (now owned by Bank
of America). According to their attorney, ML employed the same mechanism as GS
on behalf of Magnetar (discussed below).

[http://www.businessweek.com/news/2010-04-16/merrill-lynch-
us...](http://www.businessweek.com/news/2010-04-16/merrill-lynch-used-same-
alleged-fraud-as-goldman-bank-claims.html)

------
ashbrahma
The great american bubble machine. Excellent article about GS by Matt Taibbi
on the Rolling Stones magazine:
[http://www.rollingstone.com/politics/story/29127316/the_grea...](http://www.rollingstone.com/politics/story/29127316/the_great_american_bubble_machine)

------
dpatru
This American Life had a program on this last weekend:
[http://www.thisamericanlife.org/radio-
archives/episode/405/i...](http://www.thisamericanlife.org/radio-
archives/episode/405/inside-job)

------
known
I think breach in <http://en.wikipedia.org/wiki/Chinese_wall> in GS is
responsible for the subprime crisis

------
va_coder
It'll be interesting to see which political campaigns Goldman contributes to
in this year's election.

------
cryptnoob
What everybody here is forgetting, is that this is a civil suit. Why not
charge them criminally?

Bottom line, this has been staged to defang them in front of next weeks house
hearings on banking reform. It's theater. That's not to say it might not be
true, but if you really think the administration wants to clean things up, ask
why this is a civil action.

~~~
anigbrowl
The SEC lacks authority to bring criminal prosecutions. The DoJ has to do
that, although the SEC may assist them. Not sure what role they can or do play
in criminal proceedings brought by the State of New York.

------
va_coder
Perfect example of the deck being stacked against the little guy

------
justlearning
would anyone know what would be the fall out from these charges?

~~~
anigbrowl
I'll hazard a guess (and it is no more than that - IANAL), based on the
complaint and the cited statute:

\- about $2 million in direct fines

\- return of the $15-20 million GS made in brokerage fees

\- return of any bonuses made by 'Fab' Tourre

\- 'equitable relief...appropriate or necessary for the benefit of investors'

This last is extremely open-ended and the nature of such relief is up to the
court. It can take many possible forms and I have no idea what the norm is in
such cases, only that it is technically complex.

It does strike me, however, that the complaint specifically mentions two
investors; IKB, a german bank, lost $150m; and ACA (who may or may not be
considered 'investors' in this context) fell into the arms of Royal Bank of
Scotland, who ended up paying ~$860 million to GS, most of which went to
Paulson & co. This figure is mentioned explicitly in the complaint.

Now, RBS got into trouble themselves (partly as a result of this), and at this
point are ~80% owned by the British government. Fabrice Tourre, the Goldman VP
at the center of the complaint, currently an executive director of Goldman
Sachs International, based in London.

This coincidence might or might not have a bearing on the outcome. Knowing the
British tabloid press, I'm willing to bet that at least one of tomorrow's
front pages will feature a picture of Mr Tourre with a caption along the lines
of 'have you seen this man?'

------
dmillar
GS is a good buy today.

~~~
dwwoelfel
I disagree. If you want to invest, you have to look at your investments in the
context of your entire portfolio. Money invested in GS is money that can't be
invested elsewhere. There's a good chance that GS will trade down or sideways
over the next month. During that time, you could have invested in something
with better short term prospects.

The following blog post goes in to more depth on this idea, with Massey
Energy's recent mine explosion as an example.

[http://www.fundmymutualfund.com/2010/04/massey-energy-mee-
st...](http://www.fundmymutualfund.com/2010/04/massey-energy-mee-still-
struggling.html)

------
Tawheed
Too bad VCs haven't figured out a way to short startups yet.

------
startuprules
1\. Sell doomed products to stupid clients

2\. Short those products

3\. Profit X 2 !

3a. If fail, have taxpayer pay for it

~~~
dpapathanasiou
_3a. If fail, have taxpayer pay for it_

That's the most disturbing part of all this: profits are kept private, but
losses are socialized.

It's the equivalent of "heads, I win; tails, you lose".

~~~
gaius
You'd think banks paid no tax.

When banks profit, society gets its share of those profits. Taxes, spending by
the organization, spending by employees, their taxes. The government bailed
out Detroit, why's this any different?

~~~
grandalf
Not sure why you inferred that anyone above supported the auto company
bailouts (or the airline bailouts, etc.).

Taxes are not paid in exchange for bailouts... at least if they are tell that
to all the other companies that have failed over the years and not had the
government swoop in to help.

~~~
gaius
That's true, but the assertion that that there's no contribution to the
economy and society from bank profits is a false one.

~~~
Psyonic
I don't disagree with that, but simply asserting they pay taxes doesn't prove
anything. If they more or less stole the money, paying back 20% is hardly
contributing. Not saying they did, the verdict is still out there, but just
pointing out that taxes alone don't say much.

------
sabat
Seven words: Federal Pound-Me-in-the-Ass Prison.

OK, yeah, I know, they're only civil charges. But a boy can dream.

------
known
Too little. Too late.

~~~
anigbrowl
Disagree. I would rather the delay than the SEC going on a fishing expedition
and being unable to make the charges stick and undermining its own credibility
in the process.This is a very high-profile target and my [i]hope[/i] is that
SEC investigators are taking a 'measure twice, cut once' approach.

------
csomar
Dow, Nasdaq and SP50 are sliding down. I wonder how much this will affect the
economy.

------
byrneseyeview
This is a novel legal theory. Goldman is being sued because they did not
disclose that people on the opposite side of a trade had opposing opinions.
Basically, they facilitated a transfer of wealth from the stupid to the smart,
and now they're getting punished.

If Goldman made some kind of material misstatement about the quality of the
products, that's a different matter. But so far, there's no indication of
that. They helped execute a deal between two consenting, informed parties;
suing them is like suing a condom manufacturer because they facilitated the
one-night stand that turned into an unpleasant relationship.

~~~
lhuang
The SEC alleges that GS committed fraud by not informing investors that the
"3rd party objective manager" who cherry-picked the assets that were packaged
in the CDO was at the same time betting against the very assets he picked.

That, and recorded conf calls show that GS analysts as trying to convince
rating agencies to inflate the ratings of the underlying assets in the CDO.

~~~
byrneseyeview
That's just plain stupid. If you're buying, don't count on the seller having
your interests at heart.

That's part of Goldman's job. They want the transaction to happen; if they can
get a good rating, they should. The entity that's responsible for making the
rating agencies rate things well is... the rating agency.

~~~
dandelany
There is a massive difference between expecting the seller to have your best
interest at heart, and expecting that the seller will give you accurate
information regarding what product they are selling you.

The first is naivete. The second is Federal securities law.

