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Why I Think Goldman Is Guilty

Posted by Larry Doyle on April 19, 2010 9:30 AM |

Information is everything.

Regular readers of Sense on Cents know how often I have raised that point as being perhaps the most important factor on Wall Street. Information, timely access to information, and the reliability of that information all move markets. Who gets the information, how it is processed and shared, and how it is disclosed all play a very important factor in determining winners and losers on Wall Street.

Against this backdrop, why do I think Goldman Sachs will ultimately be found guilty of the fraud charges brought against it on Friday? Based on discussions I have had with Wall Street colleagues, Goldman Sachs utilized a law firm in this specific Abacus transaction which did not mandate full and proper disclosure. As such, I believe the law firm itself will also face potential charges for aiding and abetting a fraud.

What should have been disclosed? The fact that the hedge fund, Paulson and Co., was heavily involved in selecting the reference collateral used in the deal and was simultaneously taking the other side of the trade.  That information is unbelievably powerful and damaging. Why? As an investor, the immediate question that would come to mind is “What does he know that I don’t know?” If investors were in possession of that information, then they could raise the question and determine the true nature of the transaction. What was the true nature? The fact that Paulson and Co. selected mortgage collateral, which from what I have been told, was largely reflective of mortgages originated in the most overheated states and had the greatest risks of default.

Goldman apologists would state that Paulson and Goldman were merely taking the other side of the housing bet from investors. The fact is, though, the bet was not on a diverse pool of collateral (which would have mitigated the risks), but on a concentrated pool of mortgage collateral which accentuated the risks.

Investors should have asked these questions, but in my opinion Goldman had an obligation to disclose the fact that the mortgage collateral was concentrated and selected by Paulson. As such, I believe Goldman will be found guilty of perpetrating a fraud. The fraud, however, rises well beyond the individual structuring the transaction. That structurer, Fabrice Tourre, was supervised by a manger. That manager should be sweating bullets right now. Why? A failure to properly supervise is a very serious charge on Wall Street.

How high will this go within Goldman Sachs? Will it ultimately cost Lloyd Blankfein his job? Do not discount that possibility.

In the court of public opinion, Goldman Sachs has already been found guilty for taking and losing in regard to the greatest risk of all. That risk is one of a questionable reputation.

Goldman Sachs has the reputation they deserve. To a large extent, Wall Street as an industry does as well.

LD

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  • phil trupp

    You’ve hit many essential points: lack of supervision; lack of transparency; rigging of the CDO; the continuing pattern of non-transparency; collusion.

    Yes, Goldman has earned its reputation. It has made itself the bully pulpit of Wall Street as well as the bully, and every I-bank, every broker-dealer, hedge fund, rating agency and wire house is going to feel the heat. It’s overdue.

    The New York Times quoted a source as saying GS will fight hard against the allegations, and that when GS decides to fight, “it’s war.” But this is a war they can’t win. As you’ve pointed out quite aptly, GS’s latest bag of tricks has sealed its reputation as a double-dealing predator. As for John Paulson & Co., they, too, will evolve from relative obscurity (at least the public mind)and come into the light as just another fixed casino operation.

    Frankly, I’m cheered by these disclosures. The SEC actions strengthen the case for tighter financial regulation. It puts the heat on the Party of NO to break its childish political lock-step and “purity” testing and turn its energies to the mandate of protecting a public that has suffered a terrible and undeserved financial drubbing.

    Human nature seems to include in its DNA an unfortunate tendency toward oligarchy. Perhaps the GS-Paulson debacle will suppress this tendency. We can’t eliminate the problem entirely, but we can do a better job in spotting the symptoms and avoiding another economic pandemic.

  • On a contrarian note (would you expect anything else from me?), The fact that only a civil case was brought against GS is very discouraging. It brings to mind two possibilities: one is that the government has such poor evidence that they knew they could not meet the level of proof demanded by a criminal proceeding. the other is even worse: they’re bringing a civil suit because the range of penalties is so limited that ‘slap on the wrist’ becomes a vast overstatement. One might easily suspect that they don’t really want to hurt their ‘friends’ (i.e., campaign contributors) so they’ve prepared a whitewash faux trial.
    Dylan Rattigan wants to know why we don’t subpoena all their emails going back to before Lehman Bros collapsed – it’s a good question. I want to know why Hank Paulson isn’t behind bars.

    • Mike

      I might have to agree w/ the contrarian opinion. I feel like if GS was to be taken down it would’ve happened a while ago.

    • Vin

      I agree. I think this case is a joke. In all the billions GS has stolen over the years on inside information, they bring a lame case like this? My instincts tell me that the SEC HAD to do something about all the talk about GS and chose to bring a weak case to lose on purpose so they can purport to the public like “we tried”. GS says they lost $90mm on this specific trade. They are the best at “hedging” and making money on another trade. Even if you subpeonaed GS on the BSC and LEH debacle that they made billions on, they will say it was hedging counterparty risk. Maybe that is why they are so cocky, they have all the bases covered.

  • divvytrader

    why this GS accusation a joke ……………. —

    3 tidbits for the folks screaming in joy that the vampire squid is going down this time ……

    1) Henry Blodgett out with a piece today pointing out that Paulson & Co gave a list of 125 different deals they wanted put in the Abacus deal and only 50+ from that list got selected by ACA Capital ……. so much for the idea that Paulson handpicked the deal and got what he wanted .

    2) ACA actually insured this deal and went out of business in large part after this deal that they hand picked the bonds for blew up in its face . Anybody really want to believe that ACA committed corporate suicide so that Paulson could make $$$ ?

    3) GS is so confident they did nothing wrong that an internal probe at GS has cleared ‘ The Fabuilous Fab ‘ from an y wrongdoing and that he will get paid his bonus for 2009 ………

    like i told a very senior blue chip NY lawyer over the weekend who asked what i thought , i said the following : did he recall how Al Capone probably murdered 100’s of people but government could never prove it ? So they instead wwent after him for tax evasion and were able to convict him on this and jail him long enough that he died in prison ? Think GS as being like Capone only their tax work is 100% thoroughly accurate and beyond reproach once it gets yanked out in court and dissected …….

    head SEC clown on TV today does NOT look very confident . It turns out the whole case is a function of a rather shady guy who worked at Paulson and was the main guy who helped tell GS what it wanted in the Abacus deal . This guy got paid many millions by Paulson in bonus money but apparentlyt had a falling out with Paulson so this smells of ‘ disgruntled employee ‘ charges ………..

    for all the many things that GS has done that probably DO need some looking into ? this was the wrong one ……….

    • LD

      Your points are good but by opening the can of worms the collateral damage may not be able to be contained. Investor lawsuits and the like may drag on for a long time. A few judges sympathetic to the investors may make life miserable for GS and Lloyd. He may have to throw himself on the funeral pyre as a form of self-sacrifice.

      Will be interesting.

    • CalDre

      Divvytrader – are you long Godman, or a Godman employee?

      “1) … Paulson & Co gave a list of 125 different deals they wanted put in the Abacus deal and only 50+ from that list got selected by ACA Capital ……. so much for the idea that Paulson handpicked the deal and got what he wanted .”

      He got this from the SEC complaint, so don’t think you’ve stumbled onto anything ingenious. The fact is Paulson was driving the deal and ACA was hired by Godman only as a cover (as per the SEC complaint). Fab/Godman lied to ACA, telling them Paulson was long (held the equity portion). Moreover, Paulson got to review the suggested additions to the portfolio by ACA, and was able to remove the best bonds from the pool (those packaged by Wells Fargo).

      Again, all of this is in the complaint, perhaps you should read it before mouthing off like you know something?

      “2) ACA actually insured this deal…”

      First, that’s not really true – ACA off-loaded that risk to ABN Amro, which was acquired by RBS, and which was a contributing factor to RBS’ near-failure (and its massive bailout by England – which is itself now evaluating a suit againt the Godman to recover the taxpayer losses).

      Second, as noted above, Fab/Godman deceived ACA into believing Paulson held the equity trache, thereby causing ACA to believe they had a shared economic interest, as opposed to a diametrically opposed one.

      “3) GS is so confident they did nothing wrong that an internal probe at GS has cleared ‘ The Fabuilous Fab ‘ from an y wrongdoing and that he will get paid his bonus for 2009 ”

      Ahh, you mean, fraud and screwing clients is so pervasive at Godman that they don’t even care anymore, and even reward it. Yes, we know. That’s why the country’s going down the tank. But when all the lawsuits are over (and I sure hope that all of the plaintiffs are smart enough to go after the PERSONAL fortunes of all the banksters involved in the deals), Godman will no longer be too big to fail.

      • divvytrader

        CalDre :

        Nope ….. never a GS employee and not long the stock but almost was earlier today @ $158 .

        You are dead wrong on ACA . They were hired at insistence of the German AAA buyer and ACA refused to go along with the 125 names Paulson wanted and the losses from this deal were what helped put ACA under .

        You are like many other folks i know screaming about GS for years all excited at the case thinking your ship has come in trying to prop up a VERY shakey case .

        oh my …..whats this ? rumor out there that there wasn’t even unanimous agreement within SEC to pursue this case ? thats not good …. no wonder Andy Cuomo is nowhere to be found to answer the obvious question of why no criminal complaint .

        even worse , look who is out there laughing about how good the ‘timing’ of the charges were to help jam Financial Reform bill home …… Chris Dodd and Dick Durbin both on TV today equating their bill’s opponents with being GS supporters …..same Chris Dodd who is being forced into early retirement for his own fraud and bribery ?

        yup . Change you can believe in …….

        and there goes Goldman stock green by a dollar ?

        oh me , ogh my

        • CalDre

          “You are dead wrong on ACA . They were hired at insistence of the German AAA buyer and ACA refused to go along with the 125 names Paulson wanted and the losses from this deal were what helped put ACA under .”

          Where is this in the Complaint? Read Para. 53 – IKB demanded the portfolio be selected by “an independent third-party with knowledge of the U.S. housing market and expertise in analyzing RMBS.” Instead, they got a portfolio selected by the counterparty to the swap, which had selected the portfolio for the purpose of failure.

          Also ACA, whom Godman misled into believing Paulson was long the portfolio, allowed Paulson to pick 56% of the underlying securities (the understanding all along was that about 90 securities would be used, Paulson proposed 125, and of those 55 were used, and ACA selected a number, which Paulson winnowed down, removing the most solid ones (underwritten by Wells Fargo), ending up with 35 selected by ACA). Paulson was in the driver’s seat since without its participation, the deal would not have happened. Hence Paulson had to be satisfied with the portfolio. Indeed, it seems Paulson had more input than ACA into the resulting portfolio.

          ACA also claims it was misled by Godman and Fabman into believing Paulson was long. Again, Paulson’s economic incentives in the transaction seem quite material to me.

  • Fred

    I applaud the SEC for finally becoming a regulatory enforcement agency, it’s about time.

    I also applaud Paulson for taking his fiduciary responsibility seriously. His position that the housing market was overvalued and he wanted to take a short position to benefit his clients is now the envy of every trader.

    Maybe, rather than a co-conspirator, Paulson was skeptical of GS putting together a product that would participate fully in any market decline. Rather than illegal, his skeptisism is a lesson for every fiduciary.

    What are GS disclosure requirements? Clearly they were acting as a market maker with Paulson, but their role may have changed as this product evolved into it’s final form and other players including Paulson were brought in. What if they met initial disclosure requirements with the longs, before the short side was even considered, must they then update their original disclosure? Clearly, the insurers examined the product before issuing insurance, what was GS disclosure req’t with them?

    Many fiduciaries do not do “due diligence” and their decision is based upon the potential return the credit rating assigned. If it sounds to good to be true it probable is. To me the real villians are the fiduciaries (of which GS may have been one) and the credit rating agencies whose rating did not fully reflect the risk.

  • CalDre

    It’s far more egregious than that, according to the SEC’s allegations. According to those, Paulson came to Godman with the deal; Godman knew nobody would buy the crap CDOs if they explained the circumstances; so Godman roped in ACA to cover the fact that the “sponsor” designed the deal to crash (and, further, misrepresented to ACA that Paulson was long, rather than short, the underlying securities). In other words, Godman went way out of their way, even incurring extra fees (to ACA), in order to deceive potential investors about the nature of what they were peddling. This alone should tell you all you need to know about Godman’s ethics.

    Beyond that, I stumbled across a copy of the flip-book. The term sheet includes ACA as the “Portfolio Selection Agent” but lists “None” as “Portfolio Advisor”. Since Paulson clearly acted as the advisor, this is actual fraud (assuming the Internet copy was accurate).

    • LD

      CalDre….that color in regard to the Flip Book is truly fabulous, and dare I say extremely incriminating. Thanks for sharing!!

    • Fred

      CalDre,

      Unlike you, I am skeptical of the allegations, I don’t just assume they are true. I also do not agree with you that just because Paulson is not listed as an advisor it is fraud unless or until the gov’t proves it’s case.

      • CalDre

        I haven’t assumed they are true, we are discussing how strong the case is (i.e., we are discussing whether the allegations, if true, amount to a violation of law or not).

        As to Paulson: the SEC’s complaint alleges that Paulson and ACA jointly selected the portfolio (in the end, Paulson had to sign off on the portfolio, or the deal would not have happened – this is clear from the facts alleged in the Complaint regarding the selection process, and from the very fact that Paulson hired Godman to engineer this deal, meaning that the deal would not have happened if Paulson had backed out if it thought the portfolio was likely to perform well). Not only was Paulson not listed as a “Portfolio Selection Agent”, it appears from the flip-book (which I don’t think was in the SEC complaint) was affirmatively represented that there was no “Portfolio Advisor”.

        If these facts are true, Godman is screwed. I think that is fraud for sure.

        • Fred

          What if Paulson told GS they weren’t interested in the deal unless the portfolio had certain specific features, ie. included certain states, adjustible low no mtgs. Are they acting as advisors or just descriminating investors? I’m sure customized securities are put together all the time, it doesn’t make it right, but it also, in my opinion, may not qualify Paulson as an advisor.

          • CalDre

            The facts as alleged make Paulson more than an advisor – they make them a co-portfolio selection agent (indeed, the dominant one). As alleged, Godman selected ACA, which wasn’t needed for any legitimate reason, only to put a “trusted brand” on the crap they were selling – i.e., to increase the deception – and excluded Paulson because they knew the investor would not purchase the shit unless they believed the portfolio was selected by a competent, independent third party.

            I’ll add another tidbit here: I have spent 10 years living in Germany. The investor who got duped was a German bank. I have friends who work in German banks. Thus, while it doesn’t matter as a legal matter, as a practical matter I am EXTREMELY confident that the German bank would NOT have purchased the junk if they knew the nature of Paulson’s involvement – never in a million years, they are very conservative and would not bet against a hedge fund on US real estate (what does a German banker in Duesseldorf know about the US mortgage market? to claim they were so “sophisticated” just because they were a big bank is absurd, like most money managers they were relying on a third party expert, ACA, to make the picks, but again, BOY WERE THEY FOOLED!)

  • mo_mentum

    My question is this: would the SEC even care about this if the mortgages performed and Paulson LOST a bunch of money? There is no real way to glean “inside information” on a pool of mortgages; there are only opinions about future performance.

    • LD

      Mo,

      I disagree. The inside info has to do with the concentration risks along with the reps and warranties which were in place or not in place.

  • Bill

    There’s a school of thought out there that this case is crap. I don’t know enough of the facts, law or background to judge one way or the other. But the timing of this sure is questionable vis a vis Obama’s big push on his “financial reform.” Beyond that, according to what I read this CDO was of the synthetic variety, which frankly I don’t comprehend, a situation in which I’m confident I’ve got a lot of company. But apparently by its very nature there are long and short sides to it, I guess because it is composed of some sort of derivatives. Also, as I think the wsj in an editorial pointed out, at the time this thing was put together, Paulson’s involvement would not have been anywhere nearly as significant, as Paulson had yet to ascend to luminary status in its analysis of the subprime universe.

  • CalDre

    One more thing to add re: disclosure issues. In this deal, if the underwriter or distributor (Godman here) is found to have engaged in fraud, the primary remedy available to the investor is restitution – that is, the deal is unwound, and the investor gets interest from the date of investment until payment.

    This is a massive risk for a bank, like Godman, since generally you receive only a (relatively small) placement fee, but you are risk for the ENTIRE PRINCIPAL AMOUNT of the security – particularly in a structured finance deal, where the bank does the disclosure (and hence cannot go after the “issuer” to claw the money back if they are sued).

    So when you are looking at Godman’s risk management system, their decision was: do we disclose Paulson’s participation (after all, what is the downside here if the information is not material to the investor????), or not disclose and risk personal liability for $1 billion? Obviously Godman knows that it is standard practice to disclose (and they did in fact disclose, but only in part) the party selecting the assets. But they made a conscious decision not to disclose Paulson’s involvement to the investors (though Fab DID report this involvement internally, up the chain of command).

    I think the only reason not to err on the side of caution here, given the HUGE risks involved, is if you were pretty sure the deal would not close if you revealed it.

    • LD

      CalDre,

      Your color here has been fabulous. Thank you.

      • Fred

        CalDre,

        Your color may be good but your assumptions are not. I am not a supporter of GS only an admirer of Paulson. Let’s not forget that the majority of the “allegations” were supplied by a “disgruntled” Paulson employee who may have had a hidden adgenda.

        • CalDre

          Pauslon is not being sued and if he committed fraud, there is nothing to admire about that (not saying he did, nor is he being accused).

          As to the “allegations”, the SEC has been investigating for several years, and subpoenaed Godman over 6 months ago. They obviously have also been speaking with the responsible folks at ACA, IKB and ABN Amro. Hence they have heard from everyone involved.

  • divvytrader

    SEC Said to Vote 3-2 to Sue Goldman Sachs Over CDO Disclosures 91

    By Jesse Westbrook
    April 19 (Bloomberg) — The U.S. Securities and Exchange
    Commission split 3-2 along party lines to approve an enforcement
    case against Goldman Sachs Group Inc., according to two people
    with knowledge of the vote.
    SEC Chairman Mary Schapiro sided with Democrats Luis
    Aguilar and Elisse Walter to approve the case, said the people,
    who declined to be identified because the vote wasn’t public.
    Republican commissioners Kathleen Casey and Troy Paredes voted
    against suing, the person said.

    • CalDre

      Have Republicans ever investigated a Wall Street bank? I think they are too hooked on the campaign contributions and revolving door. Dems are too, which is why it is remarkable the case was brought at all.

      But when you are taking on the most powerful corporation in the country, that butters the bread of many many politicians, I would have to think the politicians would err on the side of caution – or corruption – and not bring the case. The Repugs were the ones that didn’t even pursue Madoff even though his scam was an open secret. What does them voting against enforcement mean? NOTHING!

  • Carl Jones

    Goldman is a NWO decoy, maybe sacrifice to protect the Fed.

  • divvytrader

    <> good to see CalDre just another angry supporter of Dear Leader who cannot believe Americans don’t love and furious at his plunge in the polls ……. now Madoff is a ‘Repug’ failure ? oh sure …….

    • CalDre

      How blissful it must be to live in your binary world! Not much to think about, just two world views to select from: twiddledee, and twiddledum. I see you have picked twiddledum, congratulations!

      As to Madoff, prithee do tell, who controlled the SEC from 2001 on, when Markopolos handed Madoff to the Repugs on a silver platter? Well, seeing as you are a twiddeldum, it must have been the twiddledees, eh?

      • Vin

        CalDre..brillliant perceptions. Very helpful. Thank you.

  • henry

    every phenomenon has two sides — the weapons of mass destruction that saddam had & the fraud that madoff wasn’t committing were two sides of the same coin during the bush years

    as to paulson, prosecutors ought to be going after hank, not john — when goldman set up abacus all the wall streeters commenting in the news media thought housing was going to go up in value for eternity — it was easy to find so-called experts willing to bet against john paulson

    as to hank paulson, the story that the world was coming to an end was a lie — we have bankruptcy laws to deal with failed companies — obama’s backing of another law to handle too-big-to fail entities will only weaken the existing role of bankruptcy, besides confirming that washington considers some banks as being too big to fail, which is the same lie that hank paulson foisted on the public — one suspects that the new law has some hidden pork

    the moral is that both major parties are in cahoots with the bankers

    anybody who thinks the tea party is any better hasn’t looked at how palin & other tea partiers are eager to fight wars everywhere — the tea party is a growing subset of the republican party

  • Ourmom1

    After watching the (lets call it disagreement) back and forth I am able to see what this administration has been able to accomplish. Does it not seem ironic to anyone this issue with Golden Slacks is coming out at the EXACT same time when Obama begins his next America tour. I wouldn’t be suprised if he is calling this one the National Financial Tour. What began as a debate on the Golden Slacks charges has now come to comments on the Tea Party and a belief that Tea Party members are republicans and they want to fight or go to war or whatever their president has been able to infiltrate their minds with. Think for yourselves and don’t let anyone convince you they are right without first looking in to on your own. I am not a republican just the opposite and I went to my first Tea Part gathering last week. No talk of fighting. Not a bunch of republicans talking about war. As a matter of fact almost everyone there was older than me and I am 55. Comments like “anybody who thinks the tea party is any better hasn’t looked at how palin & other tea partiers are eager to fight wars everywhere — the tea party is a growing subset of the republican party” is either drinking Obama tea or has never been to a Tea Party meeting or rally. I was a democrat and I went to both. A north Dallas meeting and east Texas rally. Go to one then talk about what you really know.
    The financial problem began with Carter decided all Americans should have the “right” to own a home. Legislation was outlined and during the 90’s and with the help of Clinton, Barney Spank was able to enact it. Oh you say Barney? Yep the same one who all of a sudden is pointing fingers. And because many of you will bring it up as to why didn’t Bush stop it during his term the answer is (drum roll) everybody’s hero ( just kidding) McCain tried to but my party the democrats had the majority and said no. Hey isn’t that what one of you called the republicans? Blame us or blame them. Personally I don’t want to let Obama to control me so I say blame all Americans for what we have here. Back to my story so now Spank man has made it so banks gotta loan to non-qualified peeps and do. But time passes and realization sets in. Gee whiz we have a bunch of bad loans here. Whats a smart outfit like Goldman gonna do? Hey lets hedge our bet and therefore we will own the loan and hedge it and the difference between is ours to keep! Sounds familar you say? Hmm have you guys been betting with a book maker cause that is exactly how they make their money! Care should be taken when allowing the wolf to guard the hen house. That wolf wants more and will continue to try and throw us off guard.

  • My Country

    Hey LD

    I have been following this whole Goldman/SEC blow-up quite closely. I think Goldman (and other firms too, as we will surely see) is absolutely guilty of not being a fiduciary time and time again.

    I can’t believe the US media isn’t all over the boardroom shenanigans going on when Hank Paulson was in charge. How did he pick the winners and losers in this game? How come Goldman got the chance to be a bank holding company and get TARP money but Lehman and Bear didn’t?

    How much in advisory fees has Goldman earned from the government? Even if that number is ZERO, why should the American taxpayer trust these guys? They have had influence on just about everything – Neel Kashkari – ex-Goldman guy, designed TARP, now at PIMCO – think he didn’t have a hand in allowing certain firms (including his own) to win?

    Is Goldman currently advising the US government on ANY matter? (Ask the FDIC and the Fed) WHY? The Europeans are furious – they got sold a bag of goods by all these investment banks and now they’re finding out that Goldman is in there advising their government? The call from over there is GET THEM OUT OF OUR HOUSE and I’m not sure why it isn’t the same here at home.

    These IB’s all violated a sacred principle of financial institutions and that is TRUST. Shouldn’t they have to earn it back before we give them the keys to the house again?

    Love your column






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