WASHINGTON, DC – Goldman Sachs is facing civil fraud charges from the US Securities and Exchange Commission (SEC) for allegedly making misleading statements and omissions relating to a synthetic collateralised debt obligation (CDO). German regulator Bafin and the UK Financial Services Authority (FSA) have also launched investigations into the bank’s conduct. The SEC lawsuit is focused on a CDO called Abacus 2007-AC1, which closed in April 2007. The complaint, filed on April 16 in the Southern District Court of New York, names as defendants Goldman Sachs and Fabrice Tourre, a London-based vice-president at the bank who formerly worked on its structured product correlation trading desk in New York. Tourre is alleged to have deliberately misled investors, according to email evidence within the SEC complaint, while marketing its prospects to clients before the subprime mortgage crisis. “You have Tourre as a named defendant so in that way this is similar to the Bear Stearns case [the 2009 trial and acquittal of Bear Stearns subprime fund managers Ralph Cioffi and Matthew Tannin],” says Jay Gould, partner at law firm Pillsbury Winthrop Shaw Pittman. “There are many ways this case could go. Goldman could say it was just one person and take a hit for failure to supervise. The complaint is quite short and contains broad allegations, with little specific evidence. We know they are pleading about whether the way this product was put together was fraudulent or not, but we don’t know the specific evidence.” The fraud allegations hinge on the allegedly leading role played by New York-based hedge fund Paulson & Co in selecting the underlying assets of the portfolio. The hedge fund had apparently identified a portfolio of 123 subprime residential mortgage-backed securities (RMBS) it wanted to short, and had approached Goldman Sachs to help it purchase credit default swap (CDS) protection on those names. The SEC claims Goldman Sachs and Paulson discussed the creation of a CDO, which would allow the firm to participate in selecting a portfolio of reference obligations and then short the portfolio by entering into a CDS with Goldman to buy protection on specific layers of the capital structure. The lawsuit says Paulson & Co reaped a $1 billion profit by betting against the performance of the securities as the subprime mortgage market deteriorated, while investors in the deal, such as Düsseldorf-based IKB and ABN Amro, subsequently acquired by Royal Bank of Scotland, lost $150 million and $840.91 million, respectively. Insurance firm AIG is also reportedly considering legal action after losing $2 billion insuring $6 billion in Goldman CDOs. “They have to say that,” says Gould. “If the SEC case succeeds then you could have other people who lost money piling in, saying Goldman helped structure a product in a fraudulent manner, with material information being withheld from one side of the transaction.” According to the reference portfolio for Abacus, the CDO consisted of a portfolio of 90 residential mortgage-backed securities rated Baa2 by New York-based Moody’s Investors Service. By January 2008, 99% of the portfolio had been downgraded. In the marketing material circulated in February 2007, New York-based ACA Capital Management is named as portfolio selection agent. ACA sold protection on the $909 million super-senior tranche of the CDO, but passed its credit risk to ABN Amro, which had acted as an intermediary, when ACA ran into financial difficulties in late 2007. The SEC lawsuit alleges Goldman realised it would be difficult to sell the CDO to investors without an “independent, objective third party”. According to the SEC, the primary role of ACA was to provide – knowingly or unknowingly – much-needed legitimacy to the product, despite the fact Paulson allegedly selected the underlying assets. The SEC says Goldman misrepresented the role of Paulson in its discussions with ACA, leaving the collateral manager with the erroneous impression Paulson would invest around $200 million in the equity tranche of the CDO. “It looks like Goldman Sachs wanted ACA to believe Paulson was an equity investor. When ACA tried to test that impression, Goldman Sachs didn’t really reply. You could certainly fault ACA a little for not nailing that down,” says a former senior official at ACA Capital Management, who was involved in the transaction while at ACA. The SEC acknowledges the Abacus portfolio was passed to ACA for review and significant changes were made. In an email on January 22, 2007, ACA told Goldman it had included only 55 of the original 123 names after its analysis. Goldman says ACA was an experienced CDO manager and, as the largest single investor, had “an obligation and every incentive to select appropriate securities”. The former ACA official says the firm would not have been involved in the transaction if it knew Paulson had a say in the selection of the underlying assets and was planning to bet against the securities contained in the portfolio. However a reported document passed to CNBC refutes this by suggesting ACA manager Laura Schwartz was made aware of Paulson’s intended position. For its part, Goldman says it never represented to ACA that Paulson would be a long investor, and that according to normal business practices “market-makers do not disclose the identities of a buyer to a seller and vice versa”. The bank also says the product was marketed to sophisticated investors who were provided with enough information about the portfolio to carry out their own due diligence before investing. Goldman admits it made $15 million in fees from the deal. It also claims to have lost $90 million itself investing in the Abacus CDO, which it says proves it “did not structure a portfolio that was designed to lose money”. “It turns on how much information each side had, and whether all material information – that a purchaser or seller in securities needs to know to make an informed decision – was disclosed to both parties,” says Gould. “That’s going to be difficult because it’s not an open-and-shut case.”...
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