Is Overstock.com in a Death Spiral?

Last Friday, Overstock.com (NASDAQ: OSTK) reported a fourth quarter net loss of $3.4 million compared to net income of $14.9 million in the previous year’s fourth quarter. Its revenues declined 10% to $314.1 million compared to $348.9 million in the previous year's fourth quarter. Details of the fourth quarter financial results were so bad, that Overstock.com did not present a full income statement for that quarter in its press release. Instead it only provided key metrics of its fourth quarter numbers and presented a full year income statement. For the entire year, Overstock.com reported a net loss of $19.4 million compared to net income of $13.9 million in the previous year. Its 2011 revenues decreased 3% to $1.054 billion compared to $1.090 billion in the previous year.

As of December 31, 2011, the company reported a net working capital deficit (current assets less current liabilities) of $14.1 million. Overstock.com's negative net working capital balance indicates that it’s having problems paying its bills as it entered into its traditionally weakest quarter of the year (the first quarter of 2012). Overstock.com common stock closed at $6.11 per share, down $0.77 per share as investors reacted to the company’s horrible earnings report.

Overstock.com inserted new language in its 2011 10-K report warning investors that, “We may not be able to achieve profitability on a quarterly or annual basis in the future.” In addition, the company warned that its poor financial performance could disrupt its relationships with suppliers concerned about getting paid.

Overstock.com will have to raise substantial amounts of new cash to pay its bills and avoid possible insolvency. The company's direct and indirect costs of raising new funds could be so onerous that the company and its current shareholders could be left in even worse financial straits. It's known as a "death spiral."

If the company raises equity, the amount of new funding required by it to stay afloat could significantly dilute the value of its existing common shares and send its stock price spiraling down even further. If Overstock.com tries to raise cash in the form of debt its interest rates could be much higher because of its deteriorating financial condition and the looming possibility of bankruptcy. Higher interest costs would increase future losses.

Overstock.com faces an ongoing investigation by the Securities and Exchange Commission after it was discovered that the company violated various accounting rules to inflate earnings in past years. District Attorney’s from seven California Counties are suing Overstock.com for alleged consumer fraud and are seeking over $15 million of restitution, fines, penalties, and cost reimbursements from the company. Last May, the Judge in that case had to compel Overstock.com to turn over information to the California District Attorneys after they complained to the court that it was illegally withholding subpoenaed documents. On December 28, 2011, The Huffington Post reported that a study found, “The site with the dubious honor of proffering the worst customer service in 2011 was Overstock.com, those ubiquitous merchants of discounted furniture, clothes and home furnishing.”

Suppliers concerned about getting paid

In its 2011 10-K report, Overstock.com warned investors that its suppliers may require it to prepay for its purchases and might suspend doing further business with the company due to its poor financial performance:

Financial performance concerns may cause fulfillment partners or other suppliers to limit or suspend doing business with us, or require prepayments.

We rely upon our fulfillment partners and other suppliers for the product offerings sold on our website and other products and services we use to run our business. Our ability to retain or attract new fulfillment partners and other suppliers may depend in part on our financial performance. Poor financial performance may create concern about our creditworthiness, which could result in suppliers choosing to limit or suspend doing business with us or require us to prepay for our purchases, which could harm our business, prospects, financial condition and results of operations. [Emphasis added.]

Overstock.com's inventory decreased $9.121 million to $22.993 million as of December 31, 2011 compared to $32.114 million in the previous year. Its accounts payable increased $3.021 to $70.332 million from $67.311 million in the previous year. When a company owes out more money to its suppliers despite a drop in inventory, it indicates that the company delayed payments to its suppliers. Overstock.com was able to temporarily spruce up its reported cash flows from operations and free cash flows by $12.142 million because it's taking a longer amount of time to pay its suppliers ($9.121 million from reduction of inventory plus $3.021 million increase in accounts payable). However, the window dressing of cash flow numbers is only temporary since it will have to pay those vendors during the first quarter of 2012. (Note: There is a $77,000 discrepancy between the increase in accounts payable on the balance sheet and the increase in accounts payable in the statement of cash flows.)

Is Overstock.com in a death spiral?

Patrick Byrne

Overstock.com could require approximately $50 million to cover its $14.1 million working capital deficit and provide a cushion to keep it afloat. As of February 10, 2012, there were 23.387 million shares of outstanding common stock. Since the company is expected to continue losing money in the next few quarters, it may have to raise all its funds in the form of equity instead of debt. With new equity instead of debt, the company won't have to pay potentially onerous interest costs and risk higher losses.

On Friday, Overstock.com common stock closed at $6.11 per share, down $0.77 per share. Based on Friday’s stock price, $50 million of new common equity would require Overstock.com to issue at least 8.183 million new common shares ($50 million new equity divided by $6.11 per share) which could dilute existing shareholders by 35% (23.387 million outstanding shares divided by 8.183 million new shares). A potential 35% dilution of existing shareholders stakes could send the stock spiraling below $5 per share and force Overstock.com to issue even more shares.

Many institutions will not own stock that is trading under $5 per share. If certain institutions sell their stock or other institutions cannot buy the stock due to that limitation, Overstock.com shares could spiral down even further. Most stocks cannot be margined under $5 per share and other investors may choose to avoid buying its shares if they cannot borrow against it.

Canadian fund manager Francis Chou takes a bath on Overstock.com investments

Francis Chou

One person who has taken a bath while trying to support Overstock.com's stock price is Canadian fund manager Francis Chou. From January 1, 2011 to January 6, 2012, Chou's funds purchased 1,041,029 Overstock.com thinly traded common shares as it dropped from $16.48 per share on December 31, 2010 to $6.99 per share on January 6, 2012. Chou's funds paid an average price of $10.63 per share.

At Overstock.com's closing stock price of $6.11 per share last Friday, Chou's funds are down $4.54 per share (26%) on its recent investments in common stock. To date, Chou's funds have invested approximately $57 million in the company’s common stock and own approximately 14% of all its outstanding common shares. Chou's total investment is losing over $35 million (over 60%).

Overstock.com CEO Patrick Byrne had better timing than Francis Chou. Back on May 20 to May 24, 2010, Byrne's 100% controlled High Plains Investments LLC dumped 140,000 common shares at an average price of $22.11 per share and collected over $3 million in proceeds.

Is Overstock.com CEO Patrick Byrne on his way out?

In the 2010 10-K report, Overstock.com stated that:

Our performance is substantially dependent on the continued services and on the performance of our senior management and other key personnel, including Patrick M. Byrne, our Chief Executive Officer. [Emphasis added.]

While, in the 2011 10-K report, Overstock.com stated that:

Our performance is substantially dependent on the continued services and on the performance of our senior management and other key personnel.

The 2011 10-K report omitted Byrne’s name. It could be a subtle hint that he could be on his way out. His leadership has been a liability to the company.

Lies to investors and accounting shenanigans

On December 11, 2001, Overstock.com CEO Patrick Byrne appeared on Fox News claimed, “We're profitable.” Brenda Buttner asked, "Your real honest-to-goodness profit, not pro forma?" Patrick Byrne responded, "None of that stuff." On March 1, 2002, Business 2.0 Magazine reporter Owen Thomas asked, "Are you profitable? Patrick Byrne responded, "Yes, that's real GAAP profit, not Amazon-bullshit-accounting profit."

On March 5, 2002, Overstock.com filed an S-1 registration statement in connection with its planned initial public offering. It contradicted Byrne’s claim to Fox News that his company was anywhere near “profitable.” At that time, the company lost money in each and every quarter since its inception. It lost $13.8 million in 2001 and lost $2.997 million in the quarter ended December 31, 2001. In February 2003, Overstock.com filed its 2002 10-K report. It contradicted Byrne claim to Business 2.0 that Overstock.com was profitable. Overstock.com reported a loss of $9.725 million in the quarter ended March 31, 2002.

When Patrick Byrne could no longer lie about Overstock.com’s profitability, he resorted to breaking accounting rules to create fictitious earnings.

Over the last several years, this blog has detailed various illegal accounting shenanigans used by Overstock.com to materially overstate its financial performance. From Q2 2007 to Q2 2008, the company used improper EBITDA calculations to materially inflate its pro forma earnings in violation of S.E.C. Regulation G. For example, in the quarter ended June 30, 2008 Overstock.com reported a positive $1.117 million EBITDA using an improper calculation instead of a negative $0.430 million EBITDA had it complied with Regulation G. From Q4 2008 to Q3 2009, the company violated Generally Accepted Accounting Principles (GAAP) and materially inflated its reported earnings. For example, in the quarter ended December 31, 2008, the company improperly reported a $1.014 million profit by violating GAAP instead of a $0.705 million loss.

In both cases I alerted the company by providing detailed information about its accounting irregularities. However, its CEO Patrick Byrne chose to retaliate against me rather than immediately correct its financial reports. For example, during various conference calls with investors he personally attacked me while claiming that his company was complaint with accounting rules. My accounting analysis was eventually proven correct by Overstock.com's later revisions of financial reports.

In September 2009, the Securities and Exchange Commission started an investigation of the company after I complained to the regulator. In March 2010, Overstock.com was forced to restate its financial reports to correct various GAAP violations initially identified in this blog. The S.E.C. investigation of Overstock.com is ongoing. In its recent 2011 10-K report, Overstock.com disclosed that, "...unfavorable resolution of this matter could materially affect our business, prospects, financial condition and results of operations."

In February 2011, Overstock.com was penalized by Google for cheating on its search engine optimization code to boost its search ranking and increase revenues. Overstock.com blamed Google for contributing to its drop in 2011 revenues. However, if the company did not cheat on its search engine optimization, it would have reported lower revenues in previous years and its revenues would not have dropped in the current year.

On December 6, 2011, a California Judge dismissed Overstock.com's long running litigation against Goldman Sachs (NYSE: GS). In its 2011 10-K report, Overstock.com disclosed that Goldman Sachs could, "...seek reimbursement from us of their allowable court costs."

Loan defaults, failure to make timely disclosures, and poor excuses

On December 27, 2011, Overstock.com paid U.S. Bank $20.329 million (including a $1.428 million prepayment penalty) to terminate a Master Lease Agreement (Sale-leaseback transaction) to avoid a default based on its dismal fourth quarter financial results. On January 6, 2012, Overstock.com filed an amended 8-K report informing investors of its decision to hold shareholder advisory votes on executive compensation every three years. The company failed to disclose that its amended 8-K report was filed late. Overstock.com’s failure to file a timely amended 8-K report caused its December 9, 2011 Form S-3 registration statement seeking badly needed capital to be rendered invalid. Its failure to file a timely 8-K report caused it to default on a $20 million credit facility from U.S. Bank.

However, the company did not notify investors of the loan default. Under S.E.C. rules, an “event of default” is required to be disclosed within four business days (8-K General Instructions and Item 2.04). Overstock.com improperly delayed disclosure of its failure to file timely reports with the S.E.C. and its loan default until February 17, 2012, a day after it resolved its default issues with U.S. Bank. The bank granted the company a waiver of default “effective as of September 30, 2011”, the same day that the amended 8-K report was supposed to be filed.

I asked Overstock.com to explain why it didn’t disclose that its amended 8-K report was filed late, why it delayed disclosing the credit facility default to investors for several weeks, what steps it was taking to handle its invalid S-3 registration statement.

Jonathan Johnson

During the Friday March 2, 2012 conference call with investors, company President Jonathan Johnson responded that it was not necessary to disclose that the January 6, 2012 amended 8-K filing was filed late because it was “obviously late.” However, company disclosures about the frequency of shareholder advisory votes are frequently filed using amended 8-K reports, so the fact that an amended 8-K report was filed does not imply that it was filed late. Nothing contained in the amended 8-K report made it “obvious” that it was filed late.

Jonathan Johnson also claimed that Overstock.com delayed informing investors of the default in its $20 million credit facility with U.S. Bank because:

…we determined it was not material, U.S. Bank agreed and quickly provided a waiver when we requested in that.

However, U.S. Bank did not “quickly” provide a waiver. The late amended 8-K report was filed on January 6, 2012. U.S. Bank did not grant a waiver of default stemming from the late filing until several weeks later on February 16, 2012. Until Overstock.com resolved its regulatory issues and U.S. Bank granted the waiver of default, the bank could have accelerated payment on the $17 million due under the credit facility.

The issue of materiality is determined when the loan default occurred, not weeks later when it was later resolved. It's possible that Overstock.com did not know about the default for several weeks after the late amended 8-K report was filed and U.S. Bank quickly granted the company a waiver of default after it was informed of the breach of loan covenants. However, any delay in notifying U.S. Bank of the default would indicate that Overstock.com has issues monitoring its compliance with loan covenants (a possible material weakness in internal controls).

Coincidently, a few hours after the Friday conference call, Overstock.com filed an 8-K report to inform investors that it provided the wrong phone number for them to listen to the audio replay of the call. I guess that Overstock.com thinks that a wrong telephone number is more important to disclose to investors than a default on a $20 million credit facility. In big or small matters, this company can't seem to do anything right.

Since Overstock.com's inception over a decade ago, the company has accumulated over $260 million in losses and restated its financial reports three times to correct violations of Generally Accepted Accounting Principles (GAAP). The company revised its financial reports numerous times to correct violations of S.E.C. disclosure rules. Despite Overstock.com's repeated violations of accounting and S.E.C rules and retaliation against its critics, the S.E.C. granted it a waiver and allowed it to be eligible to use a Form S-3 registration to raise new capital. If Overstock.com crashes and burns, the S.E.C. may explain to angry investors why it waived its rules to permit the company to issue more common stock and raise new capital.

Written by:

Sam E. Antar

Recent Interviews

March 5, 2011: Forbes - When Sam Antar Speaks, People Listen...and Speak Their Mind by Walter Pavlo

March 5, 2012: Trusted Professional - Reformed ‘Crazy Eddie’ fraudster reveals tricks of the trade by Chris Gaetano

March 3, 2012: Wall Street Journal - Psychos on Wall Street, by Al Lewis (Print Story and Video)

Other Overstock.com Coverage

March 5, 2012: William K. Wolfrum Chronicles - Rush Limbaugh and Overstock.com’s Patrick Byrne: Misogynists getting their due

Disclosure

I am a convicted felon and a former CPA. As the criminal CFO of Crazy Eddie, I helped my cousin Eddie Antar and other members of his family mastermind one of the largest securities frauds uncovered during the 1980's. I committed my crimes in cold-blood for fun and profit, and simply because I could. If it weren't for the heroic 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.

There is a saying, "It takes one to know one." Today, I work very closely with the FBI, IRS, SEC, Justice Department, and other federal and state law enforcement agencies in training them to identify and catch white-collar criminals. Often, I refer cases to them as an independent whistleblower. I teach white-collar crime classes for various government entities, professional organizations, businesses, and colleges and universities. I do not seek or want forgiveness for my vicious crimes from my victims. My past sins are unforgivable.

I do not own any Overstock.com securities long or short.

Goldman Sachs Settlement with SEC Ignores Company’s Duty to Provide Timely Disclosures to Shareholders about Investigation Leading up to Litigation

The Securities and Exchange Commission's settlement of a lawsuit against Goldman Sachs (NYSE: GS) over a certain subprime mortgage product sold to investors misses a key issue concerning the company's duty to provide timely and transparent disclosures to its own shareholders about government subpoenas, investigations, and pending enforcement actions against the firm. In this particular case, Goldman did not make timely disclosures about the regulator's investigation and pending lawsuit against the firm, right under the SEC investigator's noses.

Goldman Sachs chooses to keep shareholders in the dark about SEC investigation and pending enforcement action

During the summer of 2008, the SEC started investigating Goldman's marketing of a certain subprime mortgage product, known as ABACUS CDO, to investors who lost over $1 billion from that transaction.
At that time, Goldman Sachs knew that the SEC was investigating its failure to disclose material information to investors in violation of SEC Rule 10b-5 in connection with that transaction. However, Goldman Sachs did not disclose the SEC's investigation in its financial reports.

In July 2009, the SEC sent Goldman Sachs a Wells notice informing Goldman of its intention to file a lawsuit against the company. Still, Goldman Sachs chose not to disclose the SEC's pending enforcement action in its financial reports.

On Friday, April 16, 2010, the SEC filed a surprise lawsuit against Goldman Sachs and Executive Director Fabrice Tourre alleging securities fraud in connected with the company's marketing of the ABACUS CDO to investors. That day, Goldman Sachs shares plummeted from $183.31 per share to $160.30 per share or about 13%, wiping out about $12 billion of shareholder wealth.

Clearly, investors deemed the surprise news of the SEC complaint against the company as material information, unlike the management team running Goldman Sachs.

Goldman Sachs settles SEC charges

Yesterday, Goldman Sachs settled SEC charges against the firm. According to the SEC's press release:

...Goldman, Sachs & Co. will pay $550 million and reform its business practices to settle SEC charges that Goldman misled investors in a subprime mortgage product just as the U.S. housing market was starting to collapse.

Robert Khuzami

In agreeing to the SEC's largest-ever penalty paid by a Wall Street firm, Goldman also acknowledged that its marketing materials for the subprime product contained incomplete information.

In a news conference, Director of SEC Enforcement Robert Khuzami spoke about Goldman's duty to provide full and transparent disclosure to its customers but ignored the company's duty to likewise provide such disclosures to its own shareholders:

They acknowledge that their marketing materials for the ABACUS CDO contained incomplete information, and that they failed to disclose both Paulson & Company's role in the portfolio selection process, and that Paulson's economic interests were adverse to CDO investors.

The settlement also contains forward-looking reforms. Goldman has agreed to tighten internal controls and assess the roles and responsibilities of Goldman personnel and others to insure that disclosures in future offerings of mortgage and CDO products are full and accurate.

In agreeing to the settlement, we also took into account that Goldman is engaging in a broad-based self-assessment of their overall business practices that will increase transparency, evaluate and remediate conflicts, and take other steps that collectively will reduce the chances that investors in the future will be misled.

This resolution achieves the goals of accountability, punishment for past misconduct and prospective reforms that are the hallmark of a successful outcome.

Today's settlement is a stark reminder that there will be a heavy price to be paid if firms violate the principles fundamental to our securities laws - full disclosure, honest treatment and fair dealing - and those principles do not change, even if the product is complex or the investor sophisticated.

By ignoring Goldman's failure to timely inform shareholders about the SEC's investigation of the company and then pending enforcement action, the SEC is sending a message that surprising investors about investigations and enforcement actions is fair game. Moreover, a resolution requiring self-assessment is meaningless, as anyone not sleeping soundly through the last decade should know.

Today, news of the settlement sent Goldman shares 4.43% higher to close at $145.22 per share, still far lower than its $181.31 price per share the day before the SEC filed its complaint against the company.

Written by:

Sam E. Antar

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 in cold-blood for fun and profit, and 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.

There is a saying, "It takes one to know one." Today, I work very closely with the FBI, IRS, SEC, Justice Department, and other federal and state law enforcement agencies in training them to identify and catch white-collar criminals.

I do not seek or want forgiveness for my vicious crimes from my victims. I plan on frying in hell with other white-collar criminals for a very long time.

Recently, I exposed financial reporting violations by Overstock.com (NASDAQ: OSTK) as an independent whistleblower. The Securities and Exchange Commission is now investigating Overstock.com and its CEO Patrick Byrne for securities law violations (Details here, here, and here).

In addition, the SEC is now investigating possible GAAP violations by Bidz.com (NASDAQ: BIDZ) after I alerted them about the company's inventory accounting practices.

I do not own Goldman Sachs securities long or short.

Goldman Sachs Tells More Bull to Investors

The consequences of lies and deceit are far worse than the consequences of truth and disclosure. I learned that lesson the hard way, as I fought a losing battle against Richard E. Simpson, who was the lead counsel for the Securities and Exchange Commission in its successful battle against certain criminal members of the Antar family than ran Crazy Eddie. Veteran top gun SEC attorney Richard Simpson, known as a relentless "pit bull" back in the Crazy Eddie days is now lead counsel for the SEC in its lawsuit alleging fraud by Goldman Sachs (NYSE: GS) and Fabrice Tourre. Like me, Goldman Sachs and Fabrice Tourre will have to learn that lesson the hard way through litigation.

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.

SEC Complaint

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.

Relevant Law

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, or

2. Bait targets into making a rash responses that can land them into deeper legal peril.

Goldman 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:

...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.

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."

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.

[Snip]

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.

[Snip]

...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 “[0]% - [9]%: pre-committed first loss” as part of the Paulson deal structure. The description of this [0]% - [9]% 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 “[0]% - [9]%” 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."

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.

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.

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.

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

According to the Wall Street Journal:

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.

Closing comments

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.

Written by:

Sam E. Antar

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.

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. [Emphasis added.]

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. [Emphasis added.]

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. [Emphasis added.]

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. [Emphasis added.]

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.