April 16, 2010

The SEC has charged Goldman Sachs with fraud:

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

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

Bloomberg quoted a smiley-boy:

“I wouldn’t want to own Goldman stock right now,” said Keith Goddard, president of Capital Advisors, which oversees $810 million in Tulsa, Oklahoma. “If this turns out to be remotely true, do you want to be doing business with someone who doesn’t have your best interests in mind? That’s the accusation here.”

Institutional PMs routinely do business with those who don’t have their best interest in mind. It’s called trading as principal. As usual with PMs who have such an attitude, the Capital Advisors website does not appear to report any performance information.

DBRS noted:

Responding to the complaint, Goldman stated that the charges are unfounded and noted several critical points that it claims were missing from the SEC complaint. DBRS currently rates Goldman’s senior debt at A (high) and short-term instruments at R-1 (middle). The trend on all ratings is Stable.

DBRS is currently evaluating the potential impact of the allegation, which may have legal and financial ramifications for the Company. DBRS views this allegation as negatively affecting Goldman’s reputation, but the severity of any adverse impact is not yet known.

Goldman first fired back with the rather weak:

The SEC’s charges are completely unfounded in law and fact and we will vigorously contest them and defend the firm and its reputation

A little later, though, they got warmed up:

The Goldman Sachs Group, Inc. (NYSE: GS) said today: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.

We want to emphasize the following four critical points which were missing from the SEC’s complaint.

• 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.

• 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.

• 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.


In 2006, Paulson & Co. indicated its interest in positioning itself for a decline in housing prices. The firm structured a synthetic CDO through which Paulson benefitted from a decline in the value of the underlying securities. Those on the other side of the transaction, IKB and ACA Capital Management, the portfolio selection agent, would benefit from an increase in the value of the securities. ACA had a long established track record as a CDO manager, having 26 separate transactions before the transaction. Goldman Sachs retained a significant residual long risk position in the transaction

IKB, ACA and Paulson all provided their input regarding the composition of the underlying securities. ACA ultimately and independently approved the selection of 90 Residential Mortgage Backed Securities, which it stood behind as the portfolio selection agent and the largest investor in the transaction.

The offering documents for the transaction included every underlying mortgage security. The offering documents for each of these RMBS in turn disclosed the various categories of information required by the SEC, including detailed information concerning the mortgages held by the trust that issued the RMBS.

Any investor losses result from the overall negative performance of the entire sector, not because of which particular securities ended in the reference portfolio or how they were selected.

The transaction was not created as a way for Goldman Sachs to short the subprime market. To the contrary, Goldman Sachs’s substantial long position in the transaction lost money for the firm.

Hmm … let me see. Did tranche retention work in this instance? Would the SEC’s tranche retention idea have accomplished anything? Um … Nope.

But there are a few interesting things about the release. ACA Management LLC wasn’t a stand-alone management firm. It was a unit of the now defunct (I think) ACA Financial Guarantee Corp., a mono-line. No information is provided to indicate that it was not a shell firm, created to do some pretend-portfolio management. Goldman talks about its “experience”, always a suspicious sign … I know guys in this business with twenty, thirty, forty years of experience … and that experience has consisted of vapourizing client money. Don’t talk to me about “experience”.

Also, Goldman talks about losing money on the transaction. Define “transaction” please! Was it hedged? How was it positioned according to Goldman’s risk-management process?

All in all, however, it looks to me so far as if the charges are simply a mechanism whereby the boohoohoo brigade can blame Goldman for their bad investments. But we’ll see what comes out in court, if it ever gets that far.

There was an unsupported throwaway line in the DBRS response to the Basel 3 consultation that is certain to cause hilarity in some circles … so I might as well be the first to highlight it:

It is not clear to DBRS what is included or excluded from the definition of resecuritisation. DBRS would suggest that traditional ABCP be explicitly stipulated as excluded. Such assets generally performed well during the financial crisis.

A quiet day price-wise, but a heavy one volume-wise! PerpetualDiscounts lost 3bp while FixedResets lost 6bp and yields on the latter continued inching up towards 4%.

HIMIPref™ Preferred Indices
These values reflect the December 2008 revision of the HIMIPref™ Indices

Values are provisional and are finalized monthly
Index Mean
(at bid)
Mod Dur
Issues Day’s Perf. Index Value
Ratchet 2.59 % 2.67 % 55,804 20.90 1 0.0000 % 2,137.6
FixedFloater 4.94 % 3.01 % 47,686 20.39 1 0.8708 % 3,239.4
Floater 1.90 % 1.65 % 47,310 23.47 4 -0.0725 % 2,424.1
OpRet 4.89 % 3.16 % 101,453 0.28 10 -0.1399 % 2,310.2
SplitShare 6.35 % 2.20 % 140,083 0.08 2 0.0438 % 2,149.8
Interest-Bearing 0.00 % 0.00 % 0 0.00 0 -0.1399 % 2,112.5
Perpetual-Premium 5.87 % 4.77 % 32,014 15.87 2 -0.2433 % 1,837.0
Perpetual-Discount 6.15 % 6.20 % 193,896 13.64 76 -0.0319 % 1,731.3
FixedReset 5.44 % 3.97 % 495,937 3.65 44 -0.0560 % 2,169.0
Performance Highlights
Issue Index Change Notes
RY.PR.W Perpetual-Discount -1.51 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2040-04-16
Maturity Price : 20.84
Evaluated at bid price : 20.84
Bid-YTW : 5.98 %
Maturity Type : Option Certainty
Maturity Date : 2013-06-30
Maturity Price : 25.00
Evaluated at bid price : 25.85
Bid-YTW : 3.95 %
PWF.PR.L Perpetual-Discount -1.13 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2040-04-16
Maturity Price : 20.15
Evaluated at bid price : 20.15
Bid-YTW : 6.36 %
MFC.PR.B Perpetual-Discount 1.07 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2040-04-16
Maturity Price : 18.90
Evaluated at bid price : 18.90
Bid-YTW : 6.23 %
GWO.PR.G Perpetual-Discount 1.44 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2040-04-16
Maturity Price : 21.10
Evaluated at bid price : 21.10
Bid-YTW : 6.23 %
IAG.PR.E Perpetual-Discount 2.22 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2040-04-16
Maturity Price : 24.60
Evaluated at bid price : 24.81
Bid-YTW : 6.10 %
Volume Highlights
Issue Index Shares
RY.PR.P FixedReset 129,310 RBC bought 12,000 shares from anonymous at 27.53; blocks of 19,800 and 14,700 from anonymous at 27.50; 10,000 shares from anonymous at 27.47; and crossed 60,000 at 27.50.
Maturity Type : Call
Maturity Date : 2014-03-26
Maturity Price : 25.00
Evaluated at bid price : 27.49
Bid-YTW : 3.82 %
BNS.PR.N Perpetual-Discount 115,368 TD crossed 100,000 at 21.80.
Maturity Type : Limit Maturity
Maturity Date : 2040-04-16
Maturity Price : 21.71
Evaluated at bid price : 21.80
Bid-YTW : 6.05 %
BMO.PR.O FixedReset 115,250 Nesbitt crossed two blocks of 50,000 each at 28.10.
Maturity Type : Call
Maturity Date : 2014-06-24
Maturity Price : 25.00
Evaluated at bid price : 28.06
Bid-YTW : 3.64 %
PWF.PR.J OpRet 107,694 Nesbitt crossed 81,300 at 25.50; TD crossed 25,000 at the same price.
Maturity Type : Call
Maturity Date : 2010-05-30
Maturity Price : 25.50
Evaluated at bid price : 25.50
Bid-YTW : 3.16 %
BNS.PR.Q FixedReset 63,741 National bought 11,700 from Scotia at 25.81; TD crossed 46,600 at 25.88.
Maturity Type : Call
Maturity Date : 2013-11-24
Maturity Price : 25.00
Evaluated at bid price : 25.81
Bid-YTW : 3.97 %
CM.PR.M FixedReset 62,555 Nesbitt crossed 50,000 at 27.50.
Maturity Type : Call
Maturity Date : 2014-08-30
Maturity Price : 25.00
Evaluated at bid price : 27.48
Bid-YTW : 3.98 %
There were 50 other index-included issues trading in excess of 10,000 shares.

One Response to “April 16, 2010”

  1. […] Boyd Erman failed to include any of the Goldman’s four critical points highlighted here on April 16. I guess reporting what the defendant has to say isn’t really exciting […]

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