SURPRISE! Goldman Sachs accused of fraud!

[Surlethe]

NY Times

Page 1 below:

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.

The move marks the first time that regulators have taken action against a Wall Street deal that helped investors capitalize on the collapse of the housing market. Goldman itself profited by betting against the very mortgage investments that it sold to its customers.

The suit also named Fabrice Tourre, a vice president at Goldman who helped create and sell the investment.

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.

According to the complaint, Goldman created Abacus 2007-AC1 in February 2007, at the request of John A. Paulson, a prominent hedge fund manager who earned an estimated $3.7 billion in 2007 by correctly wagering that the housing bubble would burst.

Goldman let Mr. Paulson select mortgage bonds that he wanted to bet against — the ones he believed were most likely to lose value — and packaged those bonds into Abacus 2007-AC1, according to the S.E.C. complaint. Goldman then sold the Abacus deal to investors like foreign banks, pension funds, insurance companies and other hedge funds.

But the deck was stacked against the Abacus investors, the complaint contends, because the investment was filled with bonds chosen by Mr. Paulson as likely to default. Goldman told investors in Abacus marketing materials reviewed by The Times that the bonds would be chosen by an independent manager.

Mr. Paulson is not being named in the lawsuit.

In recent months, Goldman has repeatedly defended its actions in the mortgage market, including its own bets against it. In a letter published last week in Goldman’s annual report, the bank rebutted criticism that it had created, and sold to its clients, mortgage-linked securities that it had little confidence in.

“We certainly did not know the future of the residential housing market in the first half of 2007 anymore than we can predict the future of markets today,” Goldman wrote. “We also did not know whether the value of the instruments we sold would increase or decrease.”

The letter continued: “Although Goldman Sachs held various positions in residential mortgage-related products in 2007, our short positions were not a ‘bet against our clients.’ ” Instead, the trades were used to hedge other trading positions, the bank said.

In a statement provided in December to The Times as it prepared the article on the Abacus deals, Goldman said that it had sold the instruments to sophisticated investors and that these securities “were popular with many investors prior to the financial crisis because they gave investors the ability to work with banks to design tailored securities which met their particular criteria, whether it be ratings, leverage or other aspects of the transaction.”

Goldman was one of many Wall Street firms that created complex mortgage securities — known as synthetic collateralized debt obligations — as the housing wave was cresting. At the time, traders like Mr. Paulson, as well as those within Goldman, were looking for ways to short the overheated market.

Such investments consisted of insurance-like policies written on mortgage bonds. If the mortgage market held up and those bonds did well, investors who bought Abacus notes would have made money from the insurance premiums paid by investors like Mr. Paulson, who were negative on housing and had bought insurance on mortgage bonds. Instead, defaults spread and the bonds plunged, generating billion of dollars in losses for Abacus investors and billions in profits for Mr. Paulson.

For months, S.E.C. officials have been examining mortgage bundles like Abacus that were created across Wall Street. The commission has been interviewing people who structured Goldman mortgage deals about Abacus and other, similar instruments. The S.E.C. advised Goldman that it was likely to face a civil suit in the matter, sending the bank what is known as a Wells notice.

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Gotta run, or I'd post more.

[J]

If they receive anything more than a token fine I'll give up ice cream for a month. I suspect this will much like the Bank of America lawsuit where BAC slipped $35 million or so to the SEC and had all charges against them quietly dropped.

[J]

Something just occurred to me, today is OPEX (options expiration day). In the last little while there's been some crazy options action which as far as anyone tell is unprecedented with retail buyers piling in on call options (bets that the market goes higher). Then this piece of news gets reported today, tanking the markets and rendering many of those options worthless. The timing is a bit suspicious, this investigation has been ongoing for months and GS had already been served with a Wells notice, and of all days they just had to pick OPEX to release the news and cause maximum damage. I would not be surprised of GS had shorted their own shares in the last little while.

[Steel]

There will be some fallout from this, depending on how seriously this is actually prosecuted.

This is a concrete example of the fact that GS are actively trading against their clients. Practically impossible to actually avoid doing this given how many positions they have, but they are knowingly giving advice and moving against that position.

Thats a pretty serious breach of trust there. You don't want to take investment advice from someone who is literally going to take all your money and funnel it into their pocket...

[Knife]

I don't know if it will go anywhere, but I do hope it is a starting point for some political will to do something.

[Ryan Thunder]

If they receive anything more than a token fine I'll give up ice cream for a month. I suspect this will much like the Bank of America lawsuit where BAC slipped $35 million or so to the SEC and had all charges against them quietly dropped.

So they got hauled up for bribery, right?

[Rogue 9]

If they receive anything more than a token fine I'll give up ice cream for a month. I suspect this will much like the Bank of America lawsuit where BAC slipped $35 million or so to the SEC and had all charges against them quietly dropped.

So they got hauled up for bribery, right?

They didn't bribe officials; they settled the case for the relatively low sum of $35 million. That's not a crime, though it's despicable that the SEC would settle for so little considering the sums of money involved.

[Jalinth]

If they receive anything more than a token fine I'll give up ice cream for a month. I suspect this will much like the Bank of America lawsuit where BAC slipped $35 million or so to the SEC and had all charges against them quietly dropped.

One hopeful thing is who the SEC has heading up the charge - Richard Simpson.

This site has a good view from someone who was busted by Simpson and is now out of prison. http://whitecollarfraud.blogspot.com/20 ... -into.html If the US gov't is really trying to get GS, they can whipsaw them between the SEC and the Justice Department with the Justice Department nailing them for what GS says during the cover-up. The civil suit also allows discovery motions to take place, which will purely coincidentally be available for the DoJ. Assuming the vaunting GS lobbying machine doesn't derail the prosecution behind the scenes.

[J]

I'm somewhat surprised, it's gone international.

Bloomberg link

Goldman's London Units Face Formal U.K. Probe
By Caroline Binham - Apr 20, 2010

Goldman Sachs Group Inc.’s London units will be formally investigated by Britain’s financial regulator after U.S. regulators sued the bank for fraud last week.

The Financial Services Authority said in a statement today that it will begin a formal probe into the New York-based bank after the U.S. Securities and Exchange Commission filed an April 16 fraud lawsuit over Goldman Sachs’s marketing of a collateralized debt obligation.

“Following preliminary investigations, the Financial Services Authority has decided to commence a formal enforcement investigation into Goldman Sachs International in relation to recent SEC allegations,” the FSA said in an e-mailed statement. “The FSA will be liaising closely with the SEC.”

The bank faces a possible fine or ban of individuals if the FSA finds a breach of its rules. Prime Minister Gordon Brown called on the FSA, which he created in 1997, to investigate Goldman Sachs two days ago, accusing employees of the bank of “moral bankruptcy.”

It is too soon to tell if there will be a criminal investigation in the case, said Heidi Ashley, an FSA spokeswoman in a telephone interview. A spokeswoman for Goldman Sachs in London declined to immediately comment.

The SEC said that in early 2007, as the U.S. housing market teetered, Goldman Sachs created and sold a CDO linked to subprime mortgages without disclosing that hedge fund Paulson & Co. helped pick the underlying securities and bet against the vehicle, known as Abacus 2007-AC1.

To contact the reporters on this story: Caroline Binham in London at cbinham@bloomberg.net

Still not holding my breath for anything more than a slap on the wrist, maybe they'll annoy the Germans next and finally get a few fingers lopped off.

[Einhander Sn0m4n]

Germany will open fire on GS too.

British, German regulators to probe Goldman's sale of mortgage securities

Tuesday, April 20, 2010; A07

Financial regulators in Britain and Germany said Monday that they will open investigations to see whether Goldman Sachs's sale of mortgage securities broke any local laws after the disclosure that two European banks lost money on what U.S. officials allege were fraudulent deals.

London's Financial Services Authority and Germany's BaFin regulatory agency said they were coordinating with the U.S. Securities and Exchange Commission's investigation of Goldman's sale of an investment that, the SEC charges, was structured to fail.

The Royal Bank of Scotland lost an estimated $850 million and the Duesseldorf-based IKB Deutsche Industriebank lost more than $100 million on mortgage-related securities set up by Goldman.

"The FSA is investigating the circumstances of this case and whether there are any implications for the U.K.-regulated entities of Goldman Sachs," the FSA said. "If there are, we will take appropriate action."

In Germany, a spokesman for bank regulator BaFin said the agency would "follow up" with the SEC to see what action might be appropriate.

[The Yosemite Bear]

after seeing house repubs calling this an attack ok "Small Business"

I have come up with the following statement

Goldman Sachs is a small business only in the sense that a wolf dressed in a bloody patchwork of lamb carcasses is a Sheep

[septesix]

On the surface it made sense: Goldman sold these investor security that later crashed in values, and they know these are junks before hand, therefore it must be fraud!!

But the reality is actually a lot different. Goldman Sachs is acting basically as a market maker here. John Paulson want to bet short on the housing market, so he asked Goldman to create synthetic CDO that allow him to do so. Once that's done, GS act like any good market maker would do and find someone who want to bet long on the other side.

You can argue all you want about how the selection method isn't disclosed, that Goldman might "know" something their 'client' doesn't, or any number of the points. But the fact is all these supposedly sophisticated investor has all the really important information, that of what is really underneath all these deals. and they look at it and decide to buy it at the price at the time anyway.

Everyone is blaming Goldman for doing their job here. What I want to know is, what about the guys who are paid on the buy-side to really evaluate these deals? What can they possibly be smoking to think that these are good deals their firm should get into. Those guys get paid to figure out what's a good investment and what's not, and they failed big time here. And yet somehow they are the ones crying foul?

Goldman didn't sold these deals to mom and pop and small investors who don't have the resource to figure out what the heck these derivatives are. They sold them to big banks and big funds who supposedly pay a lot of money to hire "smart" people to figure out if a deal is good or not. How come no one is blaming any of those guys for fraud , for making some truly stupid decisions?

Also, i'm not defending GS for their conduct throughout the crisis. They did a lot of deplorable things. But this isn't one of them.

[J]

Problem is can the buyers actually dig into the synthetic CDO and get at the underlying? In this case the synthetic CDO written by GS is actually a series of credit default swaps which were written against a reference set of toilet paper mortgage bonds. The cashflow from the buyers of the CDSs is then packaged into the synthetic CDO then tranched and sold to various investors by GS. It's alleged that GS failed to disclose the nature of the synthetic CDO to buyers, and that they made false representations of said product to their clients. Which would be fraud.

The buyers do have a responsibility to dig through the data to determine whether the investment is fundamentally sound, however, this is often impossible with many of the complex structured finance products which we have these days. It's quite possible that buyers would never know what the actual underlying is unless it's disclosed by the seller and this is especially true when the products are layered one on top of each other.

[septesix]

Problem is can the buyers actually dig into the synthetic CDO and get at the underlying? In this case the synthetic CDO written by GS is actually a series of credit default swaps which were written against a reference set of toilet paper mortgage bonds. The cashflow from the buyers of the CDSs is then packaged into the synthetic CDO then tranched and sold to various investors by GS. It's alleged that GS failed to disclose the nature of the synthetic CDO to buyers, and that they made false representations of said product to their clients. Which would be fraud.

The buyers do have a responsibility to dig through the data to determine whether the investment is fundamentally sound, however, this is often impossible with many of the complex structured finance products which we have these days. It's quite possible that buyers would never know what the actual underlying is unless it's disclosed by the seller and this is especially true when the products are layered one on top of each other.

Actually, it's alleged that GS did not disclose "HOW" the underlaying CDS was chosen. However, what the underlaying CDS are has to be disclosed, and nowhere in the case were GS accused of hiding that. The "false" representation argument was about how Goldman only show that the underlaying were approved by ACA (another 3rd party supposedly is responsible for managing the deals) , when in fact it is John Paulson who picked them and ACA simply rubber stamped the thing.

And I don't buy the argument that it is impossible. It might be very difficult for average joe such as you and me. But those institutional investor specifically have people who are PAID to analyzes these deals. It's those people's job to figure out what the outlook for these deals are and voice their concern to their boss.

Again, it'd be different if Goldman is selling to average investor. But they were not. They were selling to counterparties who should've known better, but who didn't. Who's fault is that?

[Jalinth]

\e that's done, GS act like any good market maker would do and find someone who want to bet long on the other side.

You can argue all you want about how the selection method isn't disclosed, that Goldman might "know" something their 'client' doesn't, or any number of the points. But the fact is all these supposedly sophisticated investor has all the really important information, that of what is really underneath all these deals. and they look at it and decide to buy it at the price at the time anyway.

Everyone is blaming Goldman for doing their job here. What I want to know is, what about the guys who are paid on the buy-side to really evaluate these deals? What can they possibly be smoking to think that these are good deals their firm should get into. Those guys get paid to figure out what's a good investment and what's not, and they failed big time here. And yet somehow they are the ones crying foul?

Actually, that is exactly what the SEC is saying GS didn't do. The key piece of 10b-5 is that a public company can't "...omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading....". And the key piece of information that wasn't disclosed (per the SEC - so this is their version) is that Paulson was actively influencing (at a minimum) the selection of mortgages/CDOs going into Abacus and that he was net short (so his preferences would be inverse to those of a net long buyer) . The SEC is laying out a fairly simple case here. Fact X was material and you didn't disclose Fact X. Therefore, guilty. The fact that GS didn't disclose they were under a Wells notice might also bring them further SEC problems.

More importantly, recent research http://pda.physorg.com/_news180640677.html(abstract) is now finding that CDOs can have fundamental information asymmetry problems. Basically, sellers can arrange complex financial instruments so that all of the buyer due diligence in the world can't find the lemons and you can't prove that a particular CDO or tranche of it was a lemon in the first place. So it doesn't matter how sophisticated the buyer is - the seller can put one over on them if they happen to be ethically challenged.

[Jalinth]

Actually, it's alleged that GS did not disclose "HOW" the underlaying CDS was chosen. However, what the underlaying CDS are has to be disclosed, and nowhere in the case were GS accused of hiding that. The "false" representation argument was about how Goldman only show that the underlaying were approved by ACA (another 3rd party supposedly is responsible for managing the deals) , when in fact it is John Paulson who picked them and ACA simply rubber stamped the thing.

And if Paulson being involved is a material fact that wasn't disclosed, that is all the SEC needs to prove to win under the applicable regulations. One blogger thinks that both the complaint and the timing was made primarily to get GS to dig themselves a deeper hole by responding in haste - so they can get charged for the cover-up rather than the original deed. Which is exactly what GS did. If the SEC can get Tourre to cooperate (one reason he is the only individual listed), then those higher up in the GS food chain can get nailed.

[J]

http://www.sec.gov/litigation/litreleas ... 10-123.pdf

Oh darn, a whole 15% of their quarterly profits, that'll show them!

[Simon_Jester]

Bleh. Hard enough to sting, but not hard enough to hurt.

Though foreign countries launching their own investigations might make more of a dent, I hope...

[MKSheppard]

This is why I maintain that actually charging specific individuals with criminal charges rather than trying for fines against the company is a better way to go down to make sure this doesn't happen again.

[Admiral Valdemar]

This is why I maintain that actually charging specific individuals with criminal charges rather than trying for fines against the company is a better way to go down to make sure this doesn't happen again.

Exactly. And with corporations getting the rights of individuals, but with none of the negatives, I wonder if some reform there can be done too. Not that I expect any, since pretty much all nations are run by corporations nowadays.

[Gil Hamilton]

I agree with the principle of charging specific people with specific crimes, but with giant corporations, how exactly do you go about proving beyond a shadow of a doubt that the specific person committed that specific crime, particularly if the company isn't cooperative? I absolutely agree it would be a deterrent, except that it sounds like a recipe for decades long court trials and as many low to midlevel guys being thrown under the bus to save the executives as necessary.

[Vendetta]

This is supposed to be one of the uses of corporate personhood, because it's frequently hard to see exactly which individual person is responsible for an incident of corporate misbehaviour, and also because in the case of a multinational that person may be off in another country and difficult to stick in court, the corporation is legally held as a person and it is what appears in court.

Of course, to be effective this requires the fines levied against corporations be significant enough that shareholders feel the sting of a judgement against the corporation, because that's the only place the lash will be felt.

[K. A. Pital]

I absolutely agree it would be a deterrent, except that it sounds like a recipe for decades long court trials and as many low to midlevel guys being thrown under the bus to save the executives as necessary.

China solves this by killing or throwing to jail exactly the execs, no matter if they or their underlings took part in the offence made by a corporation. This way you don't get the "underlings are made scapegoats" problem, at the very least. Heh.

Not an ideal solution, but it's something, you know... as opposed to nothing.

[Fingolfin_Noldor]

I absolutely agree it would be a deterrent, except that it sounds like a recipe for decades long court trials and as many low to midlevel guys being thrown under the bus to save the executives as necessary.

China solves this by killing or throwing to jail exactly the execs, no matter if they or their underlings took part in the offence made by a corporation. This way you don't get the "underlings are made scapegoats" problem, at the very least. Heh.

Not an ideal solution, but it's something, you know... as opposed to nothing.

It's not so clear cut as that. In many cases, it's also the case where so and so executive ran afoul of some official, and then gets the boot via being accused of bribery.

Bribery is a way of life in business in China. Make the wrong people angry, and no amount of bribes will save you.

[Gil Hamilton]

China solves this by killing or throwing to jail exactly the execs, no matter if they or their underlings took part in the offence made by a corporation. This way you don't get the "underlings are made scapegoats" problem, at the very least. Heh.

Not an ideal solution, but it's something, you know... as opposed to nothing.

I think Asian countries have cultures more in tune with the notion that if you are running something and that something spectacularly messes up, that you are expected to die on your own sword, metaphorically (used to be literally). In China, the government has the power to say "OK, some of you fucked up, so give us your corporate account information so we can send a bill to your company for the cost of having all of you shot".

In the US, government goes out of its way to protect executives, either because the executives have spent alot of money buying powerful patrons with, uh, "campaign donations" or because politicians need to promote that they are friendly to big business out of idealism (which somehow translates to its against big business to hold businesses responsible for the crimes they may have committed). The American legal system is virtually DESIGNED such that it is extremely difficult to prosecute individuals with alot of money and people with a vested interest in it not becoming a trend for executives to get imprisoned for things that deserve jail time. After all, everyone is guilty of SOMETHING when you go high enough up.