Tornado Alley (PROG)

[StephanieVanbryce]

little more detail ..SEC Sues Goldman for Fraud

Oooh, things are starting to get interesting.



A number of journalists and commentators (yours truly included) have taken issue with the fact that some dealers (most notably Goldman and DeutscheBank) had programs of heavily subprime synthetic collateralized debt obligations which they used to take short positions. Needless to say, the firms have been presumed to have designed these CDOs so that their short would pay off, meaning that they designed the CDOs to fail. The reason this is problematic is that most investors would assume that a dealer selling a product it had underwritte was acting as a middleman, intermediating between the views of short and long investors. Having the firm act to design the deal to serve its own interests doesn’t pass the smell test (one benchmark: Bear Stearns refused to sell synthetic CDOs on behalf of John Paulson, who similarly wanted to use them to establish a short position. How often does trading oriented firm turn down a potentially profitable trade because they don’t like the ethics?)

The SEC is now mounting a civil suit against Goldman against one of its Abacus trades, which was a series of synthetic CDOs used to take short positions in real estate. Interestingly, the deal in question was on behalf of John Paulson. Greg Zuckerman’s book on subprime shorts, The Greatest Trade Ever, indicated that Paulson wanted to take down the all the credit default swaps created through the CDO issuance process (which would typically leave him 95% short the par value of the CDO, since Paulson would put up the equity tranche, usually 4-5%). The SEC may have started with this transaction because the communications between Paulson and the SEC would make it easy to show the intent, that of putting crappy CDS in the CDO.

Strange as it may seem, structured credit-related litigation is a new area of law, with few precedents. Until the credit crisis, unhappy investors seldom sued dealers and other key transaction participants.

From the New York Times:

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 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…

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….

Goldman let Mr. [John] Paulson select mortgage bonds that he wanted to bet against [for Abacus 2007-AC1] — 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. [ http://www.nytimes.com/2010/04/17/business/17goldman.html?hp ]

even more detail at the nyt .. this is from
http://www.nakedcapitalism.com/2010/04/sec-sues-goldman-for-fraud.html

The complaint is here http://www.sec.gov/litigation/complaints/2010/comp-pr2010-59.pdf