Sunday, April 18, 2010

Did a Clever SEC Bait Goldman Sachs into Compounding Its Legal Problems With the "Kiss of Death" Message?

Updated: At 3:48 AM ET 04/20/2010 on bottom

The Kiss of Death

In filing its lawsuit against Goldman Sachs (NYSE: GS) on a Friday, the Securities and Exchange Commission sent what I call the "kiss of death" message to the embattled company. In other words, the SEC wanted to stick it to Goldman Sachs and Fabrice Tourre, the Executive Director of Goldman Sachs International, who is also a defendant in the complaint. While the SEC as a practice does inform target companies and individuals of an impending enforcement action, it does not always tell them exactly when such an action will be filed.

Apparently, the SEC filed its lawsuit without giving Goldman Sachs the heads up that it was planning to file it that day. Business Insider observed that Goldman Sachs was clearly unprepared to respond to the complaint as news of the lawsuit dominated the headlines all day. Goldman issued a short denial around noon and issued an extensive denial late in the afternoon, after most people had gone packing for the weekend.

When a company or individual receives a surprise subpoena on a Friday from the SEC, it is usually designed to ruin their weekend plans. Yes, the SEC can get personal in its own way.

Usually, corporate lawyers are unavailable on short notice to work weekends. When a company or individual receives a subpoena or lawsuit on a Friday, they are left to stew in anxiety over the weekend until Monday, before their lawyers can appropriately advice them on how to respond to the SEC.

Back in the day as the criminal CFO of Crazy Eddie, I received a surprise subpoena from the SEC late Friday afternoon. I had to wait until Monday before my attorneys had time to advise me on a course of action.

The "kiss of death" message is deliberately sent on Fridays to chill the bones of criminals. Some criminals wait in anxiety during the weekend until Monday to consult with their attorneys about what to do next. Other criminals or SEC targets like Goldman Sachs don't want to wait until Monday. So they make rash decisions and major errors in prematurely reacting to the "kiss of death" message to their own peril and find themselves in legal quicksand.

Goldman Sachs chose not to wait until Monday and fully digest the implications of the SEC complaint. After a relatively short consultation with its attorneys, the company hastily issued a detailed press release later Friday afternoon that I believe will land it into deeper potential trouble. Before I discuss that issue, it's worth noting who the SEC selected to be its lead counsel in the lawsuit against Goldman Sachs.

SEC Lead Litigation Counsel: Richard E. Simpson the "Pit bull"

The SEC chose top gun Richard E. Simpson as its lead counsel in its lawsuit against Goldman Sachs and Fabrice Tourre. Coincidently, Richard E. Simpson was the same lead counsel for the SEC in its successful case against Crazy Eddie and the Antar family.

Simpson is a twenty year veteran at the SEC Enforcement Division. He could have easily made much more money in the private sector, but instead stayed at the SEC. As a former adversary who did battle against Simpson and later buckled under his pressure to cooperate with him, I found him to be very focused, knowledgeable about how criminals operate, and he knows how to bring them down.

In the Crazy Eddie days, Richard Simpson developed a reputation for turning pin stripe suits into orange prison jump suits. Simpson's investigation of the Antar family led to the capture of fugitive Eddie Antar in Israel, later imprisonment of Eddie and his brother Mitchell, and the impoverishment of other family members. Simpson won civil cases against against Sam M. Antar, Eddie's father, and other family members who were not indicted in the criminal case.

Simpson's relentless pursuit of the Antars earned him the nickname "Pit bull" from US Attorney Michael Chertoff's office, which prosecuted the Crazy criminal case. Over a fifteen year period Simpson was able to recover from the Antars more money than they made by selling Crazy Eddie stock to duped investors at inflated prices. The Antar family engaged in massive skimming before Crazy Eddie's became a public company and Simpson recovered a substantial amount of those funds from secret foreign bank accounts, safe deposit boxes, and even money hidden in Sam M. Antar's ceiling.

On June 22, 2004 Justin Feldman, former attorney for Eddie Antar, in an interview at the SEC Historical Society commented on SEC attorney Richard Simpson:
Rick Simpson. Tenacity, I'm telling you! When he wanted every dollar back we had to fight with him to get ten cents on the dollar on our fees.
After the SEC filed its complaint against Goldman Sachs and Fabrice Tourre, I was interviewed by Diane Tucker from the Huffington Post and was asked about Simpson. I told her:
Richard Simpson is a relentless litigator who brought the Antar clan to its knees.

Rick is a tough adversary. I swear he works over 90 hours a week. He's focused, aggressive, and understands the way criminals operate. He knows accounting backward and forward, which is rare for an attorney. Richard Simpson is what the SEC should be today, but unfortunately is not.
In addition, former FBI Special Agent Paul Hayes who led the criminal investigation of Crazy Eddie was interviewed by Diane Tucker. See below:
Former banker and retired FBI agent Paul D. Hayes told me on the phone he is impressed with Simpson.
"He has the utmost respect for the procedures of civil and criminal law. He lets the facts tell the story, and yet he's innovative as well. He'll investigate areas where there's no precedent in law, but are fair areas to address. That's what he did in the Crazy Eddie case."
Goldman Sachs and Fabrice Tourre could not have drawn a tougher adversary from the SEC than Richard Simpson who is a pro among pros. Like Simpson chased the Antars and their money to all ends of the earth, he can be expected to be even more relentless in his pursuit of the "high and mighty" Goldman Sachs in any long running legal marathon.

By sending the "kiss of death" message to Goldman Sachs in filing its lawsuit on Friday, the SEC led by Simpson was able to get Goldman Sachs to prematurely react to the SEC complaint and make grave errors.

Before I get to that point, let's review the SEC complaint.

The Lawsuit

On Friday, the SEC filed its lawsuit against Goldman Sachs and Fabrice Tourre alleging that they committed securities fraud by failing to disclose to investors that a certain portfolio of mortgage backed securities was substantially picked by another customer who was betting against the viability of those same securities by taking a short position against it. Goldman Sachs and Tourre are alleged to have concealed short seller Paulson & Co.'s role in selecting the underlying mortgages. Instead, they told investors that all securities in the portfolio were selected by ACA Management, a third party with expertise in analyzing credit risk. See more details from the press release below:
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.

...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.

[Snip]

...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.

...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.

...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.

...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.

...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.
Note: Bold print and italics added by me.
The SEC complaint involves a simple issue of nondisclosure to investors of material financial information governed mainly by Rule 10b-5, which I will describe in more detail later. The SEC alleges that Goldman Sachs and Fabrice Tourre should have informed investors of Paulson's role in the transaction. Download the lawsuit here.

The Cover up is more Dangerous than the Underlying Crime

Back in the day, I learned that the most dangerous time for a criminal is the cover up of a crime and not the execution of a crime. Public statements made by Eddie Antar's father and brothers in defending their actions were later successfully used against them in civil and criminal proceedings. In pursuing the Antar's, Simpson learned that criminals make hasty decisions to defend their actions which later land them into deeper legal trouble.

Many people are upset that the SEC brought civil charges against Goldman Sachs, while the Justice Department has not filed any criminal charges against the company. Back in the Crazy Eddie days, we faced two parallel probes, a civil probe from the SEC and a criminal probe from US Attorney Michael Chertoff in Newark, New Jersey.

Simpson effectively baited certain members of the Antar family into testifying and lying under oath in the civil case, rather than exercising their right against self-incrimination under the 5th Amendment to the US Constitution. Those lies told by the Antars were later used as the foundation for the successful criminal case brought to trial by US Attorney Michael Chertoff.

The Antars had effectively used the art of "bait and switch" against their customers and in a form of poetic justice they fell victim to Simpson's "bait and switch" tactics. I am certain that the Justice Department is watching the SEC investigation and litigation against Goldman Sachs, too.

After the stock market closed on Friday, a startled Goldman Sachs issued a detailed press release responding to the SEC lawsuit and possibly created a new set of legal problems by apparently misleading investors about certain issues being litigated and obscuring other issues. They took the carefully laid out bait provided by the SEC's "kiss of death" message and screwed up royally, as I will describe below.

Goldman Sachs Makes Huge Error in After Market Response to SEC Lawsuit

Rule 10b-5 prohibits public companies, their officers, and employees from making:
...any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or to engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person....
The SEC claims that Goldman Sachs and Fabrice Tourre violated Rule 10b-5 by failing to disclose material information about Paulson's role in selecting certain underlying mortgage securities and that Paulson was betting against the viability of those securities by taking a short position against them.

The Goldman Sachs press release starts out by saying:
...We are disappointed that the SEC would bring this action related to a single transaction in the face of an extensive record which establishes that the accusations are unfounded in law and fact.

Note: Bold print and italics added by me.
As I will describe below, at the very least, the SEC's allegations are founded in law under Rule 10b-5, contrary to the company's representation to investors in its press release. In addition, the press release misleads investors about the SEC complaint, too. Therefore, the Goldman Sachs press release may subject the company to additional Rule 10b-5 violations.

Goldman Sachs does not seem to realize that as a public company it cannot have a level playing field for itself in responding to allegations of fraud by the SEC. If Goldman Sachs loses the lawsuit, investors can claim that they were misled by the company's statement that "the accusations are unfounded in law and fact" under Rule 10b-5.

The press release goes on to say that Goldman lost money from the alleged fraud:
• Goldman Sachs Lost Money On The Transaction.  Goldman Sachs, itself, lost more than $90 million.  Our fee was $15 million. We were subject to losses and we did not structure a portfolio that was designed to lose money.
A common diversion technique used by criminals is to claim that they lost money from a questionable transaction to show they have no motive to defraud their victims. I lost almost $10,000 from selling my Crazy Eddie stock and initially claimed that I had no motive to defraud investors.

It is simply irrelevant that Goldman Sachs lost money on the transaction in question. The SEC alleges that Goldman Sachs and Fabrice Tourre omitted key material information from investors (rule 10b-5 violation) when they failed to disclose to them Paulson's role in selecting the underlying mortgage securities.

In addition, Goldman Sachs defended itself by claiming that the allegedly defrauded investors are "sophisticated" and was provided with "extensive information" about the underlying mortgage securities:
• Extensive Disclosure Was Provided. IKB, a large German Bank and sophisticated CDO market participant and ACA Capital Management, the two investors, were provided extensive information about the underlying mortgage securities. The risk associated with the securities was known to these investors, who were among the most sophisticated mortgage investors in the world. These investors also understood that a synthetic CDO transaction necessarily included both a long and short side.
• ACA, the Largest Investor, Selected The Portfolio. The portfolio of mortgage backed securities in this investment was selected by an independent and experienced portfolio selection agent after a series of discussions, including with Paulson & Co., which were entirely typical of these types of transactions.  ACA had the largest exposure to the transaction, investing $951 million. It had an obligation and every incentive to select appropriate securities. 
Sophisticated investors are defrauded all the time. Even if "sophisticated investors" are buried with "extensive information", the omission of one key piece of material information by itself, such as concealing Paulson's role in selecting the underlying mortgage securities and that Paulson was also shorting those same securities, can give rise to a securities law violation.

As I detailed above, under Rule 10b-5, a public company cannot "...omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading...." Therefore, Goldman misled investors in its press release when it stated that, "...the accusations are unfounded in law...." The SEC's allegations are clearly founded on Rule 10b-5.

In its press release, Goldman Sachs tried to obscure a key issue in the SEC complaint claiming that:
• Goldman Sachs Never Represented to ACA That Paulson Was Going To Be A Long Investor. The SEC’s complaint accuses the firm of fraud because it didn’t disclose to one party of the transaction who was on the other side of that transaction.  As normal business practice, market makers do not disclose the identities of a buyer to a seller and vice versa. Goldman Sachs never represented to ACA that Paulson was going to be a long investor.

Note: Bold print and italics added by me.
Here, Goldman Sachs obscures the legal issues involved in the complaint by claiming that the company, "never represented to ACA that Paulson was going to be a long investor." However, SEC complaint alleges that Goldman Sachs:
...misled ACA into believing that Paulson was investing in the equity of ABACUS 2007-AC1 and therefore shared a long interest with CDO investors going to be a long investor.
Note: Bold print and italics added by me.
Starting from paragraph 44, page 13 of the lawsuit the SEC describes in detail how Fabrice Tourre allegedly misled ACA into believing that it was a long investor and not betting against the portfolio of mortgage backed securities by shorting it.

In others words, the SEC alleges that Goldman Sachs knew that ACA was operating under the false belief that  the Paulson was "investing in the equity of ABACUS 2007-ACI" or the underlying mortgage securities, but Goldman Sachs did nothing to alert ACA to the contrary that Paulson was shorting the securities.

The Goldman Sachs press release is materially misleading to investors and it can give rise to additional securities law violations under Rule 10b-5. The SEC complaint has a very sound basis in both fact and the law under Rule 10b-5, contrary to the Goldman Sachs press release which claims that "the accusations are unfounded in law and fact."

Other Potential Disclosure Problems Facing Goldman Sachs

Before the SEC files a lawsuit, it notifies the company or individual that it is conducting an investigation and later sends them a "Wells Notice" that its plans to recommend enforcement action against the recipient. Since an SEC investigation or the receipt of a Wells Notice is considered a material event, companies must promptly disclose them to investors in 8-K filings with the SEC. However, Goldman Sachs made no such disclosure of any such "Wells Notice" in its filings with the SEC and is now open to potential litigation from investors for its failure to disclose those material events. See Business Week article here.

Closing Comments

As a criminal I learned that the cover up is always more dangerous than the crime. Whether or not Goldman Sachs knew the SEC lawsuit would be filed on Friday, the company made key errors in hastily responding to the SEC complaint that may come back to haunt the company. Sometimes it's better to just shut up!

Goldman Sachs simply lost its patience and went forward with emotion instead of logic in responding to the SEC. They should have waited until Monday.

To make matters worse, Goldman Sachs is circling the wagons around Fabrice Tourre which I believe is a big mistake. The company should have simply issued a press release saying:
Goldman Sachs does not comment on any current litigation and will address any issues in court proceedings.
In addition, Goldman Sachs could have said that:
The company takes any allegations of impropriety seriously and is placing Fabrice Tourre on leave pending the outcome of the SEC litigation.
In any company, especially a company that is the size of Goldman Sachs, there are always some employees who bend the rules or break the law and end up getting a company in legal trouble. By circling the wagons around Fabrice Tourre, Goldman Sachs raised the ante from a single employee issue involving a certain corporate transaction to a corporate wide issue involving the entire company. A very dumb move!

The public relations people and attorneys representing Goldman Sachs will get rich as they suck the company dry with fees and lead them down the river. That's what happened to the Antar clan at Crazy Eddie as Richard Simpson rightfully "deep-sixed" them too.

Written by,

Sam E. Antar

Please read  important disclosure about me below!

Note to Richard Simpson (SEC):

You whipped my rear end back in the day. The scars I received from the legal beating you gave me are still there. Not that there is anything wrong with it.

Update:

Wall Street Journal confirms SEC's "kiss of death" message saying that "Firm Contends It Was Blindsided by Lawsuit."

Nancy Miller from True/Slant writes:
Indeed, Goldman appears to have been caught completely off guard by the Friday announcement — even though it had received a Wells notice in July 2009, indicating that it was a target of an active investigation. The WSJ reports tonight that Goldman responded to the Wells notice in September. In March, Goldman contacted the SEC to check on the status of the investigation but no one responded to the request for an update. And apparently, Goldman didn’t mind that the lawyers at the SEC weren’t returning its phone call.

In his blog post, Antar zeroes in on Goldman’s assertion that the suit has no basis in “law and fact.” Big mistake if it turns out the suit really does have a basis in law and fact. After his surprise indictment, Antar says he tried to cover up his tracks and ended up in much worse trouble; indeed, covering his tracks proved to be more troublesome than the original misdeeds. Antar warns that if Goldman’s knee-jerk statements turn out to be untrue or misleading, their troubles would only deepen.
Sample Reaction to my Blog:

Investment News - SEC's 'pit bull' lead lawyer in Goldman case toppled Crazy Eddie by Aaron Elstein

When History Attacks! - What a White-Collar Felon Can Teach You

Seeking Alpha - Goldman Sachs: How Far Will the Abacus Case Spread? by John Lounsbury

Crain's New York Business - The Goldman Sachs-Crazy Eddie connection by Aaron Elstein

The Baltimore Sun - Thoughts on Goldman from a white-collar crook by Jay Hancock

The Stupid Nation - Goldman Sacked

Seeking Alpha - Monday Market Mayhem: Is Goldman's Goose Cooked? by Phillip Davis

Daily Kos - Goldman Sachs: "The Kiss of Death by PrometheusUnbound

Fav Stocks - Did the SEC Bait Goldman Sachs? Sam Antar, Criminal CFO of Crazy Eddie Makes the Case by Mike Shedlock

Alan Colmes Presents Liberaland - SEC Takes On Goldman Sachs – A Sea Change Or A Big Fish To Calm Waters? by William K. Wolfrum

Gary Weiss Blog - Man Bites Dog, or Goldman Sachs Charged by the SEC

The Big Picture - Goldman Sachs Gets the SEC Kiss of Death by Barry Ritholtz

Recommended Book:

Selling America Short: The SEC and Market Contrarians in the Age of Absurdity by Richard Sauer (Wiley 2010)

Important Disclosure:

I am a convicted felon and a former CPA. As the criminal CFO of Crazy Eddie, I helped Eddie Antar and other members of his family mastermind one of the largest securities frauds uncovered during the 1980's. I committed my crimes, simply because I could.

If it weren't for the efforts of the FBI, SEC, Postal Inspector's Office, US Attorney's Office, and class action plaintiff's lawyers who investigated, prosecuted, and sued me, I would still be the criminal CFO of Crazy Eddie today.

I do not own Goldman Sachs securities short or long. However, it did scam Goldman Sachs analyst Richard Balter about Crazy Eddie's financial reports during my criminal days as the CFO of the company.

My research on Goldman Sachs is a freebie for securities regulators and the public in order to help me get into heaven, though I doubt that I will ever get there anyway. I personally believe that some people at Goldman Sachs may end up joining me in hell.

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