Goldman Sachs: The $64,000 Question

My favorite hotel in Las Vegas is Steven Wynn’s Wynn Las Vegas and Encore. His Encore Macau opened on April 22. As revenue from Asia becomes a larger portion of Wynn Resorts Holdings, moving the headquarters from Las Vegas is being considered. If every American CEO demanded the responsibility for his or her company as does Mr. Wynn, American business would, instead of fearing the future of global completion, instead be relishing the sweet smell of opportunity. Lee Iacocca was that type of CEO at Chrysler. However, high stakes poker games, in high-roller card rooms on the strip, pales in comparison to the ultimate poker hand being played out between New York and Washington DC.

I have refrained from writing about the unexpected battle between Goldman Sachs (GS) and the United States of America. The outcome will determine the direction of the financial industry for the next generation. If I were a wagering man, I would not bet the fans’ favorite; the over-educated and overpaid Ṻbermensch investment bankers at 85 Broad St. versus the career civil servants. On the surface, Goldman has more money than God and a better rolodex. But I‘ve seen this movie before. If GS can contain this SEC civil complaint to its existing size and allow it to disappear, they can come back from this embarrassment. All will be forgotten about fraud charges.

It is a puzzlement why they chose instead to fight this civil complaint. Goldman Sachs has the financial and political wherewithal to make this disappear.

Lloyd C. Blankfein could potentially be reprising the role portrayed by Michael Milken 25 years ago. Then, Drexel Burnham Lambert occupied the role of Goldman Sachs. No one dared to even whisper a negative thing about Milken or Drexel in 1985, 1986 or 1987. That is, no one except Ivan bosky, an arbitrageur who plead guilty to securities fraud and implicated Michael Milken in several illegal securities transactions. Is there an Ivan Bosky orbiting John Paulson’s shop, or Abacus- 2007 AC1, that can be squeezed, either by Neil Barofsky, the special Inspector General for the TARP program, the SEC lead litigation counsel Richard E. Simpson, or Andrew Cuomo, New York State Attorney General?

Drexel invented the contemporary meme of masters of the universe. As the SEC civil complaint moved forward, a separate criminal probe was being developed by a little known United States Attorney from the Southern District of New York by the name of Rudy Giuliani. Long story short, after Bosky was convicted and implicated Milken in 1988, the SEC sued Drexel. The following year, Michael Milken was indicted on 98 counts of racketeering and fraud by a federal grand jury. To appreciate how important Milken and Drexel were at the time, their high yield “junk bond” financing deals accelerated the development of cable television, satellite communications, cellular telephony, resort casino gaming in Las Vegas and financed the beginning of the private equity firms. On April 24, 1990, Michael Milken pleaded guilty to charges of securities and tax violations.

Corporations can and do survive civil court convictions. Ask Bank of America (BAC) and Merrill. The kiss of death for a firm, however, is felony convictions. The US Government also has as much money as God; they also have subpoena power, a Justice Department, the FBI, the IRS, wiretaps, and the Racketeer Influenced and Corrupt Organizations Act (RICO). This current special poker game moreover features angry European countries, such as the UK and Germany, plus large angry pensions like CalPers.

Still, Goldman has to look over its shoulder for pissed-off former billionaires, the likes of Maurice “Hank” Greenberg from AIG (AIG) and Richard “Dick” Fuld, of Lehman Brothers – that may be amenable to some cosmic payback, or even singing recitals. The House of Sachs drew Judge Barbara S. Jones, whose career is steeped in racketeering and organized crime. If Goldman cannot get this case dismissed, and they are subsequently charged, prosecuted, and found guilty of felonies, the government will systematically put Goldman out of business, with the cold-blooded dispatch of Javier Bardem’s sociopathic killer, Anton Chigurh, in “No Country for Old Men.” Washington will view it as a necessary honor killing. It was Goldman’s decision to call and raise this pot when the possibility of extinction could have been removed from the equation.

So for me, the $64,000.00 question is this: It is both John Paulson and Goldman’s contention that ACA was aware, Paulson may be involved in selecting some of the mortgages for the CDO and ACA was never told that Paulson would be long. If Paulson had no greater assurance than 50% that Abacus – AC1 would fail, why would he take a position? Paulson admitted that wanted to make a killing. Why waste your time attempting to make a killing with a neutrally-structured vehicle? If he really believed the real estate market was about to crash he would want maximum exposure. Goldman would know this as well. Did Goldman not give equal advice to both clients in the same transaction? This is where their story falls apart.

The SEC complaint Against Goldman Sachs

SEC Charges Goldman Sachs With Fraud in Structuring and Marketing of CDO Tied to Subprime Mortgages

FOR IMMEDIATE RELEASE
2010-59

Washington, D.C., April 16, 2010 — The Securities and Exchange Commission today charged Goldman, Sachs & Co. and one of its vice presidents for defrauding investors by misstating and omitting key facts about a financial product tied to subprime mortgages as the U.S. housing market was beginning to falter.

Additional Materials
Litigation Release No. 21489
SEC Complaint
The SEC alleges that Goldman Sachs structured and marketed a synthetic collateralized debt obligation (CDO) that hinged on the performance of subprime residential mortgage-backed securities (RMBS). Goldman Sachs failed to disclose to investors vital information about the CDO, in particular the role that a major hedge fund played in the portfolio selection process and the fact that the hedge fund had taken a short position against the CDO.

"The product was new and complex but the deception and conflicts are old and simple," said Robert Khuzami, Director of the Division of Enforcement. "Goldman wrongly permitted a client that was betting against the mortgage market to heavily influence which mortgage securities to include in an investment portfolio, while telling other investors that the securities were selected by an independent, objective third party."

Kenneth Lench, Chief of the SEC's Structured and New Products Unit, added, "The SEC continues to investigate the practices of investment banks and others involved in the securitization of complex financial products tied to the U.S. housing market as it was beginning to show signs of distress."

The SEC alleges that one of the world's largest hedge funds, Paulson & Co., paid Goldman Sachs to structure a transaction in which Paulson & Co. could take short positions against mortgage securities chosen by Paulson & Co. based on a belief that the securities would experience credit events.

According to the SEC's complaint, filed in U.S. District Court for the Southern District of New York, the marketing materials for the CDO known as ABACUS 2007-AC1 (ABACUS) all represented that the RMBS portfolio underlying the CDO was selected by ACA Management LLC (ACA), a third party with expertise in analyzing credit risk in RMBS. The SEC alleges that undisclosed in the marketing materials and unbeknownst to investors, the Paulson & Co. hedge fund, which was poised to benefit if the RMBS defaulted, played a significant role in selecting which RMBS should make up the portfolio.

The SEC's complaint alleges that after participating in the portfolio selection, Paulson & Co. effectively shorted the RMBS portfolio it helped select by entering into credit default swaps (CDS) with Goldman Sachs to buy protection on specific layers of the ABACUS capital structure. Given that financial short interest, Paulson & Co. had an economic incentive to select RMBS that it expected to experience credit events in the near future. Goldman Sachs did not disclose Paulson & Co.'s short position or its role in the collateral selection process in the term sheet, flip book, offering memorandum, or other marketing materials provided to investors.

The SEC alleges that Goldman Sachs Vice President Fabrice Tourre was principally responsible for ABACUS 2007-AC1. Tourre structured the transaction, prepared the marketing materials, and communicated directly with investors. Tourre allegedly knew of Paulson & Co.'s undisclosed short interest and role in the collateral selection process. In addition, he misled ACA into believing that Paulson & Co. invested approximately $200 million in the equity of ABACUS, indicating that Paulson & Co.'s interests in the collateral selection process were closely aligned with ACA's interests. In reality, however, their interests were sharply conflicting.

According to the SEC's complaint, the deal closed on April 26, 2007, and Paulson & Co. paid Goldman Sachs approximately $15 million for structuring and marketing ABACUS. By Oct. 24, 2007, 83 percent of the RMBS in the ABACUS portfolio had been downgraded and 17 percent were on negative watch. By Jan. 29, 2008, 99 percent of the portfolio had been downgraded.

Investors in the liabilities of ABACUS are alleged to have lost more than $1 billion.

The SEC's complaint charges Goldman Sachs and Tourre with violations of Section 17(a) of the Securities Act of 1933, Section 10(b) of the Securities Exchange Act of 1934, and Exchange Act Rule 10b-5. The Commission seeks injunctive relief, disgorgement of profits, prejudgment interest, and financial penalties.

# # #

For more information about this enforcement action, contact:

Lorin L. Reisner
Deputy Director, SEC Enforcement Division
(202) 551-4787

Kenneth R. Lench
Chief, Structured and New Products Unit, SEC Enforcement Division
(202) 551-4938

Reid A. Muoio
Deputy Chief, Structured and New Products Unit, SEC Enforcement Division
(202) 551-4488



http://www.sec.gov/news/press/2010/2010-59.htm