During the company's recent conference call, Goldman Sachs tried to counter allegations made by the SEC in its complaint filed last Friday. However, the company did not deny certain key allegations made in the SEC complaint, specifically that marketing materials distributed to investors omitted any reference to Paulson and that investors did not know about Paulson's role in selecting the underlying securities. Instead, Goldman Sachs tried to rationalize its behavior and double talk investors in countering allegations made by the SEC in the complaint.
As I described in my last blog post, Goldman Sachs should not be commenting at all about the SEC lawsuit and should simply say, "Goldman Sachs does not comment on any current litigation and will address any issues in court proceedings." False and misleading statements made by Goldman Sachs about the SEC litigation can give rise to Rule 10b-5 claims by investors alleging fraud.
Before I begin to analyze certain comments made by Goldman Sachs, let's review the case and the relevant law.
The SEC complaint filed against Goldman Sachs and Fabrice Tourre alleged that they committed securities fraud by marketing a portfolio of mortgage backed securities to investors known as ABACUS 2007-AC1. According to the SEC press release, the marketing materials and other documents represented that all of the underlying mortgages in the portfolio were, "...selected by ACA Management LLC ("ACA"), a third party with expertise in analyzing credit risk...."
Goldman Sachs and Fabrice Tourre failed to disclose that Paulson & Co. Inc., "...played a significant role in the portfolio selection process." Paulson was betting against the viability of those same securities by taking a short position against it and its role in selecting the underlying mortgage was "...unbeknownst to investors."
In addition, the SEC alleges that:
Tourre devised the transaction, prepared the marketing materials and communicated directly with investors. Tourre is alleged to have known of Paulson's undisclosed short interest and its role in the collateral selection process. He is also alleged to have misled ACA into believing that Paulson invested approximately $200 million in the equity of ABACUS 2007-AC1 (a long position) and, accordingly, that Paulson's interests in the collateral section process were aligned with ACA's when in reality Paulson's interests were sharply conflicting.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. In addition, the SEC alleges that Goldman Sachs and Fabrice Tourre 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. Misleading ACA is a Rule 10b-5 violation, too.
The bedrock of America's securities laws can be found in Rule 10b-5 from the Securities Act of 1934 which makes it:
...unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange, to employ any device, scheme, or artifice to defraud, to make 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, in connection with the purchase or sale of any security.
Note: Bold print and italics added by me.The SEC's case against Goldman Sachs involves a case of alleged securities fraud under SEC rule 10b-5 of the Securities Exchange Act of 1934. As the so-called "gold standard" of investment banking, Goldman Sachs, with its legions of compliance officers and high paid attorneys don't seem to understand this 76 year old rule prohibits them from making false and misleading disclosures to investors, failing to disclose material information to investors, and otherwise deceiving investors.
If Goldman Sachs and Fabrice Tourre had made such disclosures to investors, the SEC would not have a 10b-5 claim against the company and Tourre. In other words, our securities laws are based on full and truthful disclosure and public companies cannot omit any material facts from investors.
Goldman Sachs Get Baited by SEC "Kiss of Death Message"
In my last blog post, I detailed how the SEC sent a "kiss of death" message by its filing of a surprise Friday lawsuit against Goldman Sachs and Fabrice Tourre alleging securities fraud. The purpose of the Friday "kiss of death" message is to:
1. Create anxiety for targets as they wait to respond to the SEC after the weekend, orGoldman Sachs took the SEC's bait by hastily responding to the lawsuit that afternoon, rather than taking an appropriate amount of time to review it and respond to it after the weekend. For example, Goldman Sachs made the erroneous claim that:
2. Bait targets into making a rash responses that can land them into deeper legal peril.
...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.The allegation of an omission of key material information about Paulson does give rise to a Rule 10b-5 claim as a matter of law and will survive possible future attempts by Goldman Sachs attorneys to dismiss those charges. On that issue alone, the company's press release is materially false and misleading when it claimed that "the accusations are unfounded in law."
Note: Bold print and italics added by me.
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.
However, Goldman Sachs ignored that the "sophisticated investors" were allegedly induced to make the transaction in question by its failure to disclose Paulson's role in selecting the underlying securities and that Paulson was betting against the viability of those same securities by shorting them. In addition, AXA was allegedly misled into making the transaction by Tourre allowing them to believe that Paulson was a long investor.
Public companies do not have a level playing field to engage a public debate on litigation matters. All press releases by public companies are subject to Rule 10b-5 and now investors can claim that they were misled by that press release and other comments made during the conference call as described below.
Rebutting Goldman Sachs
During the Goldman Sachs Q1 2010 conference call, Gregory Palm – Executive Vice President, General Counsel made the following comment to investors:
We would never intentionally mislead anyone; certainly not our clients or a counter party.
The SEC complaint also alleges that ACA was led to believe that Paulson would be buying an equity position rather than taking a contrary position against the portfolio which skewed ACA’s approach to dealing with Paulson. We simply do not believe that the evidence cited by the SEC demonstrates that ACA was misled into believing Paulson was going to be buying an equity position and the term sheets and offering circular did not reflect an equity trench.
...we actually have no idea where ACA got, assuming they did because that is alleged here the impression that Paulson was a “equity investor.”
Note: Bold print and italics added by me.However, Goldman Sachs documents cited in the SEC complaint tell a different story than the double talk offered by Gregory Palm.
First: Goldman wanted ACA's name on the transaction, not Paulson's name. Documents distributed to investors omitted any reference to Paulson.
The SEC complaint cites and "internal email from Tourre dated February 7, 2007" which states:
“One thing that we need to make sure ACA understands is that we want their name on this transaction. This is a transaction for which they are acting as portfolio selection agent, this will be important that we can use ACA’s branding to help distribute the bonds.”Second: The SEC cites Goldman Sachs documents showing how ACA was misled into believing that Paulson was a "Transaction Sponsor" and that ACA believed that Paulson was an "equity" investor.
However, Goldman Sachs and Tourre took no steps to tell ACA that Paulson was betting against the viability of the underlying mortgage securities by taking a short position in them. See below:
46. On January 8, 2007, Tourre attended a meeting with representatives from Paulson and ACA at Paulson’s offices in New York City to discuss the proposed transaction. Paulson’s economic interest was unclear to ACA, which sought further clarification from GS&Co. Later that day, ACA sent a GS&Co sales representative an email with the subject line “Paulson meeting” that read:
“I have no idea how it went – I wouldn’t say it went poorly, not at all, but I think it didn’t help that we didn’t know exactly how they [Paulson] want to participate in the space. Can you get us some feedback?”
47. On January 10, 2007, Tourre emailed ACA a “Transaction Summary” that included a description of Paulson as the “Transaction Sponsor” and referenced a “Contemplated Capital Structure” with a “% - %: pre-committed first loss” as part of the Paulson deal structure. The description of this % - % tranche at the bottom of the capital structure was consistent with the description of an equity tranche and ACA reasonably believed it to be a reference to the equity tranche. In fact, GS&Co never intended to market to anyone a “% - %” first loss equity tranche in this transaction.
48. On January 12, 2007, Tourre spoke by telephone with ACA about the proposed transaction. Following that conversation, on January 14, 2007, ACA sent an email to the GS&Co sales representative raising questions about the proposed transaction and referring to Paulson’s equity interest. The email, which had the subject line “Call with Fabrice [Tourre] on Friday,” read in pertinent part:
“I certainly hope I didn’t come across too antagonistic on the call with Fabrice [Tourre] last week but the structure looks difficult from a debt investor perspective. I can understand Paulson’s equity perspective but for us to put our name on something, we have to be sure it enhances our reputation.”
49. On January 16, 2007, the GS&Co sales representative forwarded that email to Tourre. As of that date, Tourre knew, or was reckless in not knowing, that ACA had been misled into believing Paulson intended to invest in the equity of ABACUS 2007-AC1.
50. Based upon the January 10, 2007, “Transaction Summary” sent by Tourre, the January 12, 2007 telephone call with Tourre and continuing communications with Tourre and others at GS&Co, ACA continued to believe through the course of the transaction that Paulson would be an equity investor in ABACUS 2007-AC1.
51. On February 12, 2007, ACA’s Commitments Committee approved the firm’s participation in ABACUS as portfolio selection agent. The written approval memorandum described Paulson’s role as follows: “the hedge fund equity investor wanted to invest in the 09% tranche of a static mezzanine ABS CDO backed 100% by subprime residential mortgage securities.” Handwritten notes from the meeting reflect discussion of “portfolio selection work with the equity investor.”
Note: Bold print and italics added by me.The record is clear from internal company documents that Fabrice Tourre knew that AXA believed that Paulson was a transaction sponsor and an equity investor based on his communications with AXA. Tourre did nothing to change their belief.
Apparently, Fabrice Tourre violated Goldman Sachs's Code of Business and Professional Conduct which clearly states that "It is the firm’s policy that the information in its public communications, including SEC filings, be full, fair, accurate, timely and understandable."
Yet, Gregory Palm told investors:
We have never condoned and would never condone inappropriate behavior by any of our people. On the contrary we would be the first to condemn it and to take all appropriate action.According to the Wall Street Journal in the Wall Street Journal:
Fabrice Tourre, the Goldman Sachs Group Inc. employee at the center of the U.S. government lawsuit alleging securities fraud, has decided to take some personal time off and hasn't said when he will return to work, according to a person familiar with the matter.
Goldman spokesman Lucas van Praag confirmed in an email that Mr. Tourre is on "paid leave with no end date."Goldman Sachs should have been proactive and placed Tourre on a long term leave of absence, pending the outcome of the litigation. Goldman Sachs missed a golden opportunity to cut its losses and show the public that the company, which is considered the "gold standard" in investment banking, is serious about complying with securities laws.
The 31-year-old Frenchman didn't come into his London office Monday, this person said. He remains an employee at Goldman, where he is an executive director.
It certainly would have not increased the company's litigation exposure to place FabriceTourre on a long term leave of absence, given that it appears that Tourre took such a leave of absense on his own.
According to the Financial Times, Goldman Sachs claimed:
In the bank’s view, it would have been a breach of client confidentiality to reveal that Paulson & Co intended to short the CDO.Due to Paulson's unique role in selecting the underlying securities and betting against them by shorting them, Goldman Sachs could have simply obtained a waiver of confidentiality agreement from Paulson. It's done all the time. If Paulson did not want to waive confidentiality, Goldman Sachs should have declined to do the transaction.
Failure to Inform Investors of SEC Investigation and Pending Enforcement Action
During the conference call, Gregory Palm tried to explain why Goldman Sachs failed to disclose the SEC investigation and pending enforcement action and other possible investigations in its financial disclosures:
What I would say about that is our policy has always been to disclose to our investors everything we consider to be material. That would include investigations, obviously lawsuits, regulatory matters, anything. Whether there is a Wells or not a Wells if we consider it to be material we go ahead and disclose it and that is our policy. To get to your question we do not disclose every Wells we get simply because that wouldn’t make sense. Therefore we just disclose it if we consider it to be material.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.
According to the SEC:
....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.According to the Wall Street Journal:
Investors in the liabilities of ABACUS are alleged to have lost more than $1 billion.
The Wall Street giant said it was alerted to the probe in the summer of 2008 and was warned that it might face a suit in July 2009.Therefore, by the time the SEC starting investigating Goldman Sachs "in the summer of 2008 and was warned that it might face a suit in July 2009" Goldman already knew that investors lost more than $1 billion on the transaction and the SEC was considering an enforcement action against the company due to alleged securities fraud.
An investigation and pending litigation from the SEC concerning an allegation of fraud involving a transaction that resulted in $1 billion in investor losses should certainly have been disclosed in detail by Goldman Sachs in its filings with the SEC.
In other words, investors can claim that they were deceived by Goldman Sachs's lack of specific detailed disclosure about the SEC investigation and pending litigation. Such a claim can be supported by the fact that after the SEC filed its lawsuit last Friday, Goldman Sachs shares dropped 13% that day, wiping out over $10 billion of market value.
As I said in the opening sentence of this blog post, "The consequences of lies and deceit are far worse than the consequences of truth and disclosure. That's because the cover up is always more dangerous than the underlying crime.
Goldman Sachs keeps on trying to justify its failure to disclose to investors Paulson's role in selecting the underlying securities and that Paulson was betting against those same securities by shorting them. In addition, the company seems blind to Tourre's role in allegedly misleading ACA into believing that Paulson was a long equity investor.
Goldman Sachs is opening up itself to potential new allegations of securities law violations by investors who rely on its comments about the SEC complaint. Those deceptive comments can be used by the SEC to show an intent to defraud investors in the underlying alleged securities law violation, as part of a cover up by the company.
Sam E. Antar
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.