Some “Inside Baseball” On The Goldman Case

In the post below we said that the Goldman case is a game changer. We said that based on two assumptions. One was that Goldman loses its case.

In the last 90 minutes we came across some “inside baseball” reporting that can help investors determine whether or not the SEC will win its case.

• Bloomberg.com – Goldman SEC Case May Hinge on Meaning of ‘Selected’
  The case against Goldman Sachs Group Inc. may turn on the meaning of the word “selected.” The Securities and Exchange Commission must prove that the most profitable company in Wall Street history defrauded investors by failing to disclose that a hedge-fund firm betting against them played a role in creating what they bought. It must also counter Goldman Sachs’s assertion that an independent asset manager, which the SEC said rejected more than half of the securities initially proposed by Paulson & Co. for a collateralized debt obligation, signed off on the selections. “The question is whether Paulson’s undisclosed role in portfolio selection was material,” said Larry Ribstein, a law professor at the University of Illinois in Champaign who has written about 140 articles and 10 books on topics including securities law and professional ethics. “There’s no clear and well-defined definition of what you have to disclose in this type of transaction.” The SEC case signals the regulator could eventually target other banks over how much they told investors about at least $40 billion of CDOs that turned toxic as mortgage defaults soared to the highest level since the 1930s. Robert Khuzami, the SEC enforcement chief, said last week that the agency will aggressively pursue deals “that share similar profiles.”

Comment
This story above is a rather long story and does a good job of laying out all the legal issues in this case as they are known based on a detailed reading of the SEC complaint.
Is Abacus 2007-AC1 Unique?

• CNBC – Goldman Only Did One Deal With Hedge Fund: Paulson AideAccording to sources who have read Paolo Pellegrini’s deposition in the Goldman fraud case and spoken with him, the former Paulson hedge fund manager told government attorneys that the mortgage securities deal—called Abacus—was the only one Paulson arranged with Goldman Sachs that had a neutral third party selecting the securities. The revelation raises questions about how widespread the alleged fraud is on Wall Street. While reports suggest the government is looking into other such deals, Pellegrini’s testimony suggests this particular transaction was limited. The SEC filed a civil suit against Goldman on Friday, accusing the Wall Street investment bank of misleading investors by not disclosing that Paulson’s hedge fund picked securities for the deal and then shorted—or bet against—them. Goldman denied the allegations. Paulson and Pelligrini have not been accused of any wrongdoing. In fact, according to Pellegrini, Paulson was only able to suggest what securities would go into Abacus. Instead, ACA Management—a unit of financial insurer ACA Financial Guaranty—was the primary agent in deciding what securities were included in the deal, as Goldman claims.

Comment
The story above is based on the video below, it appears that Steve Liesman of CNBC has access to deposition or other facts in the SEC case. Perhaps he has been talking to Paolo Pellegrini, Paulson’s former head trader who is believed to be a key witness for the SEC. We have found no one else that is reporting on case specifics beyond what was in the SEC complaint.

Liesman reports that the Abacus 2007-AC1 deal (pitchbook) was somewhat unique in that it was Paulson’s only CDO that used a neutral third party manager to select collateral (ACA management) or “bespoke” deal. Pauslon did other CDO deals where they picked the collateral directly and it was disclosed as such. What is not clear is if Paulson’s economic interest in those deals failing was also properly disclosed.

The implication is if Goldman loses this case it will not lead to a precedent that will spread to many other CDOs.

Liesman is also reporting on the collateral selection for Abacus 2007-AC1. Paulson originally proposed 123 deals be included. ACA rejected 55 of them. Then Paulson expanded his criteria to find more deals. ACA and Pauslon went back and forth until enough deals were included to satisfy rating agency criteria to get the desired ratings for the CDO.

As we interpret Liesman’s words (feel free to disagree), ACA was not tossing out deals because they thought they were bad for CDO buyers, but ACA was using its expertise to game the rating agencies to make sure the deal got the desired credit ratings to make it work.

Liesman also reports that “someone close to Pellegrini” says that ACA selection criteria “stacked the deck” against Paulson’s short position therefore implying that this deal is not as fraudulent as it appears. They also point out that ACA “took down” (we believe he means wrote protection against) $840 million of the $1.1 billion deal. What is not clear is if ACA did this to get the deal done and then “re-insured” this exposure with a firm like AIG right after it closed.

If you are interested in the “inside baseball” of this case, this four minute interview is worth a look.

Finally, the following video is a conversation with Josh Rosner, managing director of Graham Fisher, and Jesse Eisinger, a reporter with Propublica. It was one of the better and more informed conversations about this case.