Is Goldman innocent of the SEC accusations in the ABACUS 2007-ACI CDO transaction? I would argue that the SEC may have over stepped its bounds in filing the suit. Both sides of the deal are extremely sophisticated investors. We are not dealing with mom and pop dabblers here. Goldman hired a firm to review and approve the legality of the deal prior to execution. Needless to say, it passed the test. Since when does Wall Street ever disclose the otherside of a transaction's information? Never, in fact, it would be totally wrong. Goldman claims to have lost money on the transaction to the tune of up to $90 million. The question is was there fraud in putting together the transaction? If housing maintained its value, the CDO would have been profitable. Could have anyone been able to predict when the market would collapse?
It appears to me that the the SEC may be using this case to TEST their regulatory ability for the coming changes in financial regulation against the biggest fish in the pond. It will be interesting to see how this plays out. My bets are on Goldman.
From Bloomberg:
By Christine Harper
April 17 (Bloomberg) -- Goldman Sachs Group Inc.’s efforts
to burnish its reputation just got a lot tougher.
Chairman and Chief Executive Officer Lloyd Blankfein, 55,
spent the last year defending the firm against criticism from
politicians and pundits, who decried Goldman Sachs’s profit in
the aftermath of the financial crisis and its sale of mortgage
securities that went sour. Now the U.S. Securities and Exchange
Commission is charging the company with fraud.
On Goldman Sachs’s list of business principles, “clients’
interests always come first” ranks highest. The SEC paints a
different picture. The firm failed to tell investors when
selling them a so-called collateralized debt obligation tied to
mortgages that the package had been designed to fail by hedge
fund Paulson & Co., which profited from the losses, the agency
alleged. Goldman Sachs said it will contest the case, calling it
“completely unfounded in law and fact.” Shareholders weren’t
comforted: The stock plunged the most in more than a year.
“The risk is long-term reputational,” said Benjamin
Wallace, an analyst at Grimes & Co. in Westborough,
Massachusetts, which manages $900 million and doesn’t own
Goldman Sachs stock. “People are going to be more inclined to
look at Goldman Sachs and think, ‘Who’s on the other side of
this trade?’”
Goldman Sachs sank 13 percent to $160.70 in New York Stock
Exchange composite trading, the biggest one-day percentage
decline since January 2009. The cost to buy insurance against a
default on Goldman Sachs debt jumped 35 basis points, or 0.35
percentage point, to 130.5 basis points in the biggest increase
in a year.
‘Worst-Case Liability’
The suit’s financial cost to Goldman Sachs, whose $13.4
billion profit last year set a record for a Wall Street
securities firm, is likely to be manageable and a settlement is
unlikely before 2011, according to Brad Hintz, an analyst at
Sanford C. Bernstein & Co. in New York.
The “worst-case liability” if the SEC case succeeds would
be $706.5 million hit to net income, or $1.20 in earnings per
share, Hintz estimated in a note to investors yesterday. Follow-
on claims from investors will “face a challenging hurdle”
because the securities were sold in a private placement only
available to sophisticated investors, Hintz said.
Some analysts said that a more important problem is that
the SEC’s focus on Goldman Sachs shows the firm is under a
harsher political and regulatory spotlight than competitors.
Goldman Agenda
Although the SEC warned Goldman Sachs last year that it was
investigating this transaction and might eventually file
charges, the regulator didn’t notify the firm that it planned to
file the suit yesterday, according to a person close to the
firm. People within the company interpreted it as a sign the SEC
has become unusually adversarial, the person said.
“At the moment, it looks as if the SEC is pursuing an
agenda aimed specifically at Goldman,” Chris Kotowski, a
managing director at Oppenheimer & Co. in New York, wrote in a
note to clients. “We believe that GS is probably vulnerable to
more charges and outsized fines, and we are for now downgrading
the stock to perform from outperform.”
Reactions to the SEC suit on Capitol Hill underscored
Goldman Sachs’s role as a lightning rod for political outrage.
Senate Banking Committee Chairman Christopher Dodd, a
Connecticut Democrat, said the case demonstrates the need for
Wall Street reform. House Minority Leader John Boehner, an Ohio
Republican, said the SEC suit provides further reason to oppose
the Democrats’ legislation.
Blankfein’s Prospects
“These are very serious charges against a key supporter of
President Obama’s bill to create a permanent Wall Street bailout
fund,” Boehner said in a statement after the SEC case was
announced. The bill “gives Goldman Sachs and other big Wall
Street banks a perpetual, taxpayer-funded safety net by
designating them ‘too big to fail.’”
Corporate customers and institutional investors will
continue to rely on Goldman Sachs and the company’s business is
likely to survive and thrive, said Richard Bove, an analyst at
Rochdale Securities in Lutz, Florida. Still, he said Blankfein
and Chief Financial Officer David Viniar, 54, may need to step
down “for the devastating decline in this company’s persona.”
“These men are brilliant and capable but this situation is
now out of hand,” Bove, who recommends buying Goldman Sachs
shares, said in a note to investors. “There is a deep bench at
Goldman and these executives, despite their capabilities, can be
replaced.”
Lucas van Praag, a spokesman for Goldman Sachs in New York,
declined to comment.
Questions for Viniar
Blankfein, who has worked at Goldman Sachs since joining
its commodities division, J. Aron & Co., in 1982, succeeded
Henry Paulson as chairman and CEO in 2006 when Paulson left to
become Treasury Secretary in the Bush administration. The next
year, Goldman Sachs set a Wall Street profit record helped by
bearish bets on subprime mortgage investments. Blankfein
received a $67.9 million bonus, an all-time high for the CEO of
a securities firm.
Viniar, the firm’s chief financial officer since 1999, is
one of the most public faces of Goldman Sachs. He fields
questions from analysts and investors on the firm’s results
every quarter. He’s slated to face their questions again next
week, when Goldman reports first-quarter figures.
In their annual letter to shareholders last week, Blankfein
and Goldman Sachs President Gary Cohn said most of the firm’s
business is aimed at serving sophisticated clients capable of
making their own decisions.
Tourre and Paulson
“The investors who transacted with Goldman Sachs in CDOs
in 2007, as in prior years, were primarily large, global
financial institutions, insurance companies and hedge funds,”
the letter said. The firm “did not know whether the value of
the instruments we sold would increase or decrease.”
That contrasts with the SEC’s allegations. The suit says
Fabrice Tourre, a 31-year-old vice president at Goldman Sachs,
knew that the Paulson hedge fund firm had helped select the
assets backing a collateralized debt obligation called Abacus
2007-AC1, even as Paulson planned to bet on it failing. The SEC
says Tourre misled a collateral manager, ACA Management LLC, and
an investor, IKB Deutsche Industriebank AG, about Paulson’s
role.
“Marketing materials for Abacus 2007-AC1 were false and
misleading because they represented that ACA selected the
reference portfolio while omitting any mention that Paulson, a
party with economic interests adverse to CDO investors, played a
significant role in the selection of the reference portfolio,”
the SEC argues.
‘Cynical, Savage’
Tourre, reached yesterday at his office in London, where he
is now an executive director, declined to comment. Annette
Littmann, a spokeswoman for Duesseldorf-based IKB, said “IKB is
aware of the SEC’s lawsuit and supported the SEC upon request.”
The SEC’s accusations may fuel critics’ claims that the
firm put its own interests ahead of clients’ and profited from
practices that led to the financial crisis.
“Goldman Sachs said they sold only to sophisticated
investors, but the damage they did was so pervasive that
unsophisticated investors got snared in their web too,” said
Janet Tavakoli, president of Tavakoli Structured Finance Inc. in
Chicago.
Christopher Whalen, a bank analyst at Torrance, California-
based Institutional Risk Analytics, told investors yesterday
that “this litigation exposes the cynical, savage culture of
Wall Street that allows a dealer to commit fraud on one customer
to benefit another.”
‘Out of Character’
William Cohan, a former investment banker who is writing a
book about Goldman Sachs, said the accusations are surprising
because the firm generally is diligent when it comes to legal
disclosures. That the suit names none of Tourre’s superiors may
signal that senior management can escape blame, he said.
“It just strikes me as being entirely out of the firm’s
character, as much as people like to hate them, because they are
much too careful on the whole legal front and disclosure
front,” Cohan said in an interview.
The SEC has “only named a VP, it’s not going up the chain
here at the moment, so I think that’s an important distinction
to make,” Cohan said. “There are bad apples in any firm.”
In a statement, Goldman Sachs made what it called “four
critical points” in its defense against the SEC’s accusations.
The first was that Goldman Sachs itself lost more than $90
million because it had an investment in the deal that
overwhelmed the $15 million it made in fees.
Paulson Statement
The firm said it provided “extensive disclosure” to IKB
and ACA about the risk of the underlying mortgage securities. It
said that ACA, whose $951 million investment made it the most
exposed to risk, selected the portfolio. And the firm disputed
the SEC’s accusation that Goldman Sachs told ACA that Paulson &
Co. was going to be an investor in the CDO.
Paulson’s firm, which hasn’t been charged with any
wrongdoing, said in a statement that “ACA as collateral manager
had sole authority over the selection of all collateral in the
CDO” and that Paulson didn’t “sponsor or initiate” Goldman’s
Abacus program. The fund says that while it did purchase credit
protection from Goldman Sachs on some Abacus securities, it
wasn’t involved in the marketing.
Goldman Sachs’s loyalty to clients has been questioned
before. E-mails released by congressional investigators earlier
this week show that Washington Mutual Inc.’s former CEO, Kerry
Killinger, didn’t want to hire a Goldman Sachs banker in 2007 to
help with the bank’s credit problems before it collapsed.
Best Models, Brightest Minds
“They are smart, but this is swimming with sharks,”
Killinger wrote in an Oct. 12, 2007, e-mail to a deputy. “They
were shorting mortgages big time while they were giving CfC
advice,” he added, referring to Countrywide Financial Corp.,
the home lender that ran short of cash the same year.
One investor said that perception hasn’t prevented Goldman
Sachs from winning client business before and he doesn’t think
it will now.
“There’s that cachet that they’ve had that not only are
they the smartest guys in the room, but they might be playing
you,” said Peter Sorrentino, a senior portfolio manager at
Huntington Asset Advisors in Cincinnati, which manages about $13
billion, including Goldman Sachs stock. Still, “the people at
Goldman really do have the best models, they do have the
brightest minds” and they will keep winning clients.
He said the market reaction to the SEC’s suit probably
reflects fear that wider criminal charges could follow, and
represents a good opportunity to buy the stock.
“I’m just happy that it wasn’t the FBI kicking in the
door,” Sorrentino said.
*T
For Related News and Information:
On Goldman and legal issues: GS US
On Goldman and CDOs: GS US
Top finance news: FTOP
*T
--With assistance from Shannon Harrington, Bob Ivry, Bradley
Keoun, Dawn Kopecki, Matthew Leising and Michael Moore in New
York, Joshua Gallu in Washington, and Jann Bettinga in
Frankfurt. Editors: Robert Friedman, Otis Bilodeau.
To contact the reporter on this story:
Christine Harper in New York at +1-212-617-5983 or
charper@bloomberg.net
To contact the editor responsible for this story:
Alec McCabe at +1-212-617-4175 or
amccabe@bloomberg.net.
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