Let’s start by making one thing clear: we here at NotMakingThisUp harbor no particular good will towards Goldman Sachs.
In fact, not long ago we published in these virtual pages a column titled “Goldman 8, Public Zero…the Teachable Moment of Bare Escentuals (January 15).” It was a minor but explicit illumination of Goldman’s relationships with its clients—i.e. pretty much the same relationship a water moccasin has with a frog.
Loyal readers will recall that we described how Goldman Sachs first sold a total of 36 million shares of cosmetics maker Bare Escentuals (sic) to the public at prices ranging from $22.00 to $34.50. Then, after the wheels came off the proverbial track at Bare, Goldman’s crack research team slapped a “Sell” rating on the company’s stock…but not until after it had already collapsed to $13 a share.
Adding insult to injury, just a few weeks after that “Sell” rating—from Bare’s very own investment bank—sent the shares crashing, Bare Escentuals received a takeover bid for $18.20 a share.
But wait, as they say, there’s more!
Bare Escentuals then hired none other than Goldman Sachs to advise the cosmetics company on the $18.20 a share offer. Goldman, naturally, endorsed the price as fair—just weeks after its own research department had declared $13.00 as too rich a price for Goldman’s clients to pay—and received fees for doing so.
By our count, that amounted to eight ways Goldman Sachs made money on Bare Escentuals at the expense of anybody on the other side of the table.And while we therefore do not have any particularly benign feelings towards Goldman Sachs, neither do we harbor ill-will towards the government institution which filed a complaint against that firm on Friday.
Indeed, the SEC Chairman who, in our view, pulled the teeth out of that animal under the previous administration and then flailed ineffectually while the world collapsed thanks in part to his blunders—i.e. Chris Cox—is gone, and good riddance to him. (For an entertaining and insightful look at that sordid story, read Andrew Ross Sorkin’s excellent account of the Lehman collapse, “Too Big to Fail.”)
Still, we’ve read the SEC’s complaint filed against Goldman Sachs Friday afternoon—headlines of which seemed so shocking they sent Goldman shares, and stock markets, crashing.
And while the complaint portrays yet another sordid story—the account of some really awful paper Goldman helped package and sell to a dumb German bank at the behest of a smart U.S. hedge fund manager—we think the government doesn’t have a leg to stand on.
The gist of the SEC’s complaint—and while we are not attorneys, we have been in this business a few decades and seen more than a few frauds in that time—appears to be, in part, that Goldman and an employee mislead IKB, the German bank in question, by not disclosing that John Paulson’s hedge fund had helped select the garbage Goldman was selling to IKB:
In sum, GS&Co arranged a transaction at Paulson’s request in which Paulson heavily influenced the selections of the portfolio to suit its economic interest, but failed to disclose to investors…Paulson’s role in the portfolio selection process or its adverse economic interests.
—Paragraph 3, SEC v. GOLDMAN SACHS & Co. and FABRICCE TOURRE.
Let’s leave aside the obvious howler here—since when did it become a broker’s responsibility to violate the confidentiality of its clients by disclosing the seller’s identify to the buyer?—and focus on the specifics of the SEC charge, particularly the notion that IKB would not have proceeded with the transaction had Goldman not omitted Paulson’s name from the discussion, as spelled out here:
IKB would not have invested in the transaction had it known that Paulson played a significant role in the collateral selection process while intending to take a short position in ABACUS 2007-AC1.
—Paragraph 59, SEC v. GOLDMAN SACHS & Co. and FABRICCE TOURRE.
Who, exactly, is this IKB that, if we are to believe the complaint, had been led like a lamb to slaughter by Goldman Sachs at the behest of John Paulson?Well, IKB is short for IKB Deutsche Industriebank, and it was once a sleepy German industrial lender that, during the 2000s, made the plunge into sub-prime CDOs for the same reason so many of its peers did: it seemed like a good idea at the time.
Indeed, so good an idea did it seem, that IKB boasted of its prowess in evaluating exactly the kind of garbage the SEC is now trying to claim Goldman Sachs misled it into buying.
Far from being an unwilling pawn on the financial chess-board, IKB issued press releases about its move into the exotic world of toxic mortgage structures even as John Paulson, the genius who sold the garbage to IKB, was deciding it was time to sell the same toxic mortgage structures short.
Indeed, as far back as March, 2006—a year before the tainted transaction with Goldman Sachs—IKB issued a press release announcing the closing of a deal, chest-thumpingly-named “BACCHUS” (we are not making that up) which seems to make it very clear that IKB was not only a willing buyer, but a willing distributor of the same kind of garbage as the boys in lower Manhattan.
Here begins that press release:
IKB closes first “Bacchus” deal, strengthening its position as an asset manager for corporate loan portfolios.
[Düsseldorf, Germany, 16 March 2006] IKB Deutsche Industriebank AG has successfully concluded “Bacchus 2006-1″, a funded securitisation of acquisition financings. With this deal, IKB further strengthened its position as a leading asset manager for corporate loan portfolios. The € 400 million Collateralised Loan Obligation was arranged and placed by JP Morgan…
Bacchus, of course, was the Roman god who inspired the term “Bacchanalia.”
Call us old-fashioned, but for our part, if we had been a stodgy old-line German bank packaging securities for resale, we would have selected a more sober god to name our deals after—“Apollo,” perhaps (god of music and healing; ‘associated with light, truth and the sun’), or “Artemis” (goddess of the hunt).
Not the god of drunken orgies.
Having discovered that IKB appears to have been no babe in the CDO woods, we now submit the following document that we suggest may well suffice as “Exhibit A” in Goldman’s defense.
It is a presentation by Dr. Jörg Chittka, head of IKB investor relations, prepared for a Dresdner Kleinwort Day for Investor Relations on December 12, 2006—just a few months before the transaction in question—and it can be downloaded from the IKB web site.
Let’s flip quickly through Dr. Chittka’s “slide deck”:
“Slide 3: Highlights—Market Leader/Strong performance/Solid ratings…”
—IKB Dresdner Kleinwort IR Day 12.12.2006
Hmm, IKB would seem to be no country bumpkin. This slide informs us that, among other things, IKB is a “Specialist in long-term corporate finance” and a “Market leader in long-term corporate lending in Germany” with a market share of 13%.
“Slide 5: Focused market strategy—Specialisation(sic)/Lean sales system/Selective new business…”
—IKB Dresdner Kleinwort IR Day 12.12.2006
Sounds good! Dr. Chittka informs us that IKB has a “Rating-oriented product and price strategy,” and that “New business” is “strictly oriented to rating and margin spread.”
So how on earth did IKB end up owning a bunch of Goldman-packaged, Paulson-shorted garbage?
The next slide holds a clue, in the form of a timeline showing IKB’s history:
“Slide 6: Lines of Development
· 1924: Foundation
· 1930s: Pioneered long-term lending at fixed interest rates…
· Entering 2000s: CLO-transactions and investments in international loan portfolios”
—IKB Dresdner Kleinwort IR Day 12.12.2006
Ah, there we have it. IKB is getting into the CLO business, especially in international loan portfolios!
But what does this little German bank know from CLOs? Well, it turns out this little German bank claims to possess an advantage:
“Slide 9: Competitive edge
· High expertise in all fields of corporate finance, incl.
-rating advisory and
-industry research”
—IKB Dresdner Kleinwort IR Day 12.12.2006
There you have it: IKB claims to have “high expertise in all fields of corporate finance,” and that includes both “rating advisory and industry research.”
Indeed, the IKB slide deck goes on, bragging in the kind of detail you can bet Goldman Sachs’ attorneys will be happy to share about the “excellent rating IKB enjoys” thanks to its “outstanding funding base”; the “Strong and stable customer relations based on relationship banking over decades”; the “High diversity of IKB loan book”; the “High granularity” of the IKB loan portfolio; the “Improving quality of the loan book” and the bank’s “Solid capital base for business growth.”
So confident was IKB’s management of all these things that Slide 35 boasts that “IKB is going to meet the operating profit target for the financial year 2006/2007 as a whole.”
How, exactly, would IKB perform this feat?
Slide 36 informs us that one of the ways is by the “additional investments in international loan portfolios.”
International loan portfolios such as ABACUS 2007-AC1, perhaps?
There is more—60 pages in all—but from our brief review it would appear that this particular German bank took the other side of the Paulson trade not because it didn’t know Paulson was selling.
After all, at the time the deal was structured in early 2007, John Paulson was just “John Paulson, merger arbitrage hedge fund guy,” not “John Paulson, billionaire hedge fund manager who bet against the housing bubble and won.”
No, it would appear that IKB—creator of BACCHUS, self-proclaimed possessor of “high expertise in all fields of corporate finance,” and seeker of “additional investments in international loan portfolios”—simply wanted the other side of ABACUS, period.
From BACCHUS to ABACUS really wasn’t too long a journey for IKB, but it was deadly.And while Goldman & Company may have showed IKB the way, they did not, it would seem, drag them kicking and screaming.More like skipping and singing.Jaded we may be, but we here at NotMakingThisUp will bet, as the saying goes, dollars to donuts that at the end of the day, the score in this case looks like this:
Goldman 1, SEC 0.
Jeff Matthews
I Am Not Making This Up
© 2010 NotMakingThisUp, LLC
The content contained in this blog represents only the opinions of Mr. Matthews, who also acts as an advisor: clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews’ recommendations. This commentary in no way constitutes investment advice, and should never be relied on in making an investment decision, ever. Also, this blog is not a solicitation of business: all inquiries will be ignored. The content herein is intended solely for the entertainment of the reader, and the author.
33 replies on “From BACCHUS to ABACUS: Exhibit A in Defense of Goldman Sachs”
great stuff, jeff. the God of Drunken Orgies!
one minor thing – I don't think the SEC is saying that GS should have disclosed Paulson's name, I think the SEC is saying that GS should have disclosed the party (who happened to have been Paulson) on the other side of the trade was instrumental in the selection of the portfolio. Of course, ACA still chose the portfolio, so even this disclosure likely wouldn't have made a difference in my mind.
I certainly agree with your point, though – IKB is no innocent victim.
Jeff,
I too shed no tears for IKB. BUT, by 2007 the German bank in no certain terms had told Goldman they would not buy any more CDO's unless they were structured by an independent selection agent. Of course they knew that there was always a short party on the other end; that was how the CDO came to exist. But IKB was beginning to open its eyes and only wanted to enter trades where a third party selected the underlying reference bonds. That is what led Goldman to bring ACA in on the Abacus deal, to give IKB the impression that Goldman was following their instructions, when in fact they were still letting the short side pick the bonds. That is most certainly a disclosure failure and a misrepresentation. Trying to defend themselves by saying that GS and ACA lost money too is nonsense and a red herring. It just means that GS and ACA thought Paulson was the sucker, i.e. "Let's let this guy Paulson pick whatever bonds he wants. We still like housing so we'll go long with IKB. But in order to close the deal IKB wants it to be a 3rd party selection, so let's have ACA say that they picked all the bonds." That Goldman and ACA lost money is just desserts, but does not negate the fraud in telling IKB what they wanted to hear in order to close the deal.
Jeff, I am a fund manager and ex-lawyer who did some securities fraud litigation when I practiced law. Your piece does a great job showing that IKB was no babe in the woods. But that is irrelevant to whether GS broke the law. The relevant question is whether GS failed to disclose a "material fact" when it sold these securities. The "fact" at issue is that _someone_ who wanted to short the CDO was working to get the crappiest crap put into the CDO. It doesn't matter who the "someone" was; arguments about Goldman not disclosing Paulson's identity are a side show. To me it also seems irrelevant that ACA had "ultimate authority" over what went into the CDO, as long as they did put in the crap that Paulson was suggesting.
The real question is whether the undisclosed fact was "material" — would a reasonable investor consider it important to the investment decision. That seems fairly clear. Ask yourself: if you were about to buy a pool of assets and discovered that someone who wanted to short it was working to stuff it with the worst possible assets, would you say "that's fine, I'll buy it at the same price anyway?"
So IKB could have been the biggest, baddest, bestest CDO buyer on the planet; Goldman could be right that brokers shouldn't need to disclose "identities" on the other side of deals — and yet Goldman could still have committed fraud.
Fair enough, but someone can sell a good deal or a bad one, with a genius or an imbecile, and the fraud case boils down to one thing – did they lie?
The case seems to rest on whether anyone will testify that Goldman falsely told ACA that Paulson was an equity investor, and whether the docs and sales pitch were false, when they said the sponsor independently picked some bonds they liked.
If the Paulson guy was in the same room as the GS and ACA guys structuring the portfolio, and the deal went to ACA's 'Commitments Committee' with the statement that Paulson was the equity investor, that's pretty strong circumstantial evidence. (paragraph G.51 of the complaint)
Pure speculation, but if the GS guy in that meeting is under a civil complaint, it might be because the other people in that meeting are going to testify he lied or strongly misled them.
(I feel similarly to Apple v. Adobe, where Adobe is the idiot / greedy alleged victim (whose software seems to spend 99% of its energy updating itself, introducing crapware and security holes) and Apple is the highly competent but overreaching superpower)
All fair points, particularly this:
'The case seems to rest on whether anyone will testify that Goldman falsely told ACA that Paulson was an equity investor, and whether the docs and sales pitch were false, when they said the sponsor independently picked some bonds they liked.'
Time will tell, but our bet still stands.
JM
Gret stuff Jeff. IKB knew what was doing, they had two off balance sheet SIV (Structured Investment Vehicle) investing more that 10bil in mortgage and structured credit. ACA as well know what was doing, by that time they were manager of close to 20 CDO (if I remember correctly). Those guys had team of people looking at the underlying collateral all day long. Also according to GS latest statement ACA was not only the portfolio selector but the largest investor in the deal. So the largest investor spent days agreeing with the Paulson guys on the underlying mortgages and they didn't realize those guys were on the short side? Come on, really?
Is it really believable that an experienced portfolio manager that knows very well that given the way this CDO are structured there is always a short side to it, and that spent days discussing names with an investor that presumably never gave up in trying to put crappy names in it, never doubt its being a long investor ????
By not disclosing Paulson's role did GS deprive the investo of a crucial piece of info? To me, hardly, first, you buy something you do your homework and decide whether you believe in the trade or not. The fact that somebody has the opposite view, shouldn't affect your judgement. Second, at the time Paulson view of the market collapse was shared by a minority. And Paulson was just one of the many Portfolio managers, not the famous investor he become getting this one right.
Robert in Chicago, ACA didn't put in the crap Paulson suggested. They rejected a significant portion of it. When you were a fund manager i assume you got sales guys phoning you up and saying you gotta to put this in your fund. Some you did, some you didn't but I assume you are not claiming that the sales guys selected your investments not you….
Danny
Professor Jeff:
Your perspective on IKB is insightful yet does not change my opinion that GS allegedly committed fraud in the ABACUS deal with John Paulson and Co. I believe there is more evidence to come from the SEC which hopefully will show the scale and nature of Goldie's alleged misdeed(s). A good poker player never "tells" his hand, and Mary Shapiro at the SEC is sure to keep the heat on GS with a "winning hand" by keeping her evidence/cards close to the vest. I could be wrong in my opinion, though…
P.S. – Three quick hits by the way:
A) Wish I bought some April 2010 $170 GS Puts prior to Friday's close – talk about making a killing;
B) I wonder whether Friday's selloff in GS had anything to do with The Oracle of Omaha selling a few of his GS warrants given the reputational risk to GS with the SEC civil suit – I bet it feels like Salomon Brothers all over again;
C) I'd bet that GS posts another record 1Q10 earnings tomorrow and the stock will rally to Tuesday’s close, even with the nature of analyst questions surrounding the civil fraud case by the SEC – I could be wrong in my opinion, of course.
I'm not going to disagree with your analysis of the legal issues of this case, nor with your assertion that IKB was supposed to know what it was doing. But the bigger message here is this: Goldman Sachs and other Wall Street IB's make their money by stuffing their customers with bad product. Now, this may not be news inside the industry, but to a Main Street businessman it is anathema. There is an element of trust required in commercial transactions–buyers cannot always check up on their sellers as a matter of course. If my supplier delivers bad product I may not have any practical legal recourse, but the incident will certainly poison our relationship.
Anyone doing business with GS is going to think twice after this (especially the Europeans). Whatever the outcome of the case, it certainly can't be good for their business.
Jeff:
It seems that GS's crime was to tell IKB that Paulson was an investor, when in reality it was shorting the transaction. I suspect that GS would have been in a no fault situation if they had never informed IKB that Paulson was the equity investors, by doing so they mislead the investor as to Paulson's true position in the transaction.
At the end of the day this is all about politics! Note to Wall Street from the White House: the gloves are off.
That's the take away of this lawsuit, everything else is just window dressing
All: Let's stop using the "C" word. It's lazy and just a little too Yahoo-message-board for my taste.
Now, "But What Do I Know" says the following:
'Goldman Sachs and other Wall Street IB's make their money by stuffing their customers with bad product.'
While that is often true, as in the case of Bare Escentuals, which we described in detail, it is often not true.
Goldman, for example, brought a little company public in 1986, selling 2.8 million shares of this company to the public for $21 a share.
So on a split-adjusted basis, it now turns out that Goldman sold what today amounts to 805 million shares of Microsoft to the public at a price of 7c a share.
Was that "stuffing their customers with bad product"?
The point is that on Wall Street willing buyers meet willing sellers every day through brokers like Goldman Sachs.
Those brokers, as everyone on Wall Street knows, are peddlers. They are not your friends: they earn a commission only if you buy or sell.
They do NOT earn a commission putting their arm around your shoulder and saying 'Maybe you shouldn't do this because if the housing market collapses you could lose everything.'
In the case of John Paulson and IKB, Goldman had a willing buyer in IKB that very much wanted to buy CDOs; and they had a willing seller in John Paulson who very much wanted to short the housing market.
As far as I can see–and Aaron may be right: the SEC may be witholding stuff from the complaint, although I can't fathom why they wouldn't lead with their best cards–Goldman brokered a deal, and if that deal had worked out to IKB's benefit, we wouldn't be hearing about this…and nobody would be crying for John Paulson losing money on his hedge fund bet. He'd be just another unworthy short-seller who tried to profit on the misfortunes of others, and failed.
But Paulson did not fail: he bet right when IKB bet wrong. He won by doing what good investors do–he did his homework, bet against the world, and held that bet in the face of near-universal doubt that it would pay off the way it did.
So I'm still taking bets that at the end of the day, the score will go up on the boards: Goldman 1, SEC 0.
JM
I agree with your bet and your logic. The bigger problem for GS is the PR war. I thought it was hardcore populist backlash that always goes away but now governments are getting in on it. The risk on this one has gone way up and I think the market's reaction was appropriate. Maybe it's cheap but I would require a hedge and those aren't cheap.
Based on the information revealed to date, I also lean towards the vampire squid's side. It's hard to liken putting $100 million into a synthetic CDO with ordering industry standard chemicals, steel pipe or the like. When you know what you're buying is complicated and asset quality varies considerably, you have an obligation to do your own due diligence or not do the deal. Claiming you assumed the other side was being fair, honest and trustworthy is just another way of saying you didn't do your job.
Barry Ritholtz at http://www.ritholtz.com THE BIG PICTURE in his blog of 4/20/10 says GS will lose because it violated rule 10b-5.
Do you think Ritholtz's argument has merit?
John
Barry is simply saying Goldman violated the law and will lose (although he is saying it with classic Barry emphasis!).
I read the same SEC complaint as Barry, but I don't see the violation.
JM
The key is if GS representations about ACA and the portfolio selection process were accurate. If so, they are fine. For example, if they stated that ACA "typically consults with third parties" in constructing the security and IKB didn't ask who those were, GS is fine. If GS stated that ACA was independent and took no input from outside parties, then they have a problem. How GS represented ACA is not entirely clear from the facts that I have seen.
The gutted ranks of the SEC are probably no match for the legions of Wall Street lawyers that will help defend GS.
If the Justice Department gets involved (as they should), I will take your bet! Is it a dollar or a doughnut???
Thanks for the comments, Jeff. Interesting that you had to go back to 1986 to find a good deal for GS customers (kidding). But even so, what made MSFT a great company was MSFT, not Goldman Sachs–IMHO anyone could have brought them public.
But we're going to always disagree on the nature of Wall Street's business. There are sometimes when you need to tell your customer not to do something that he may want to do (or at least try to talk him out of it). This is "long-term greedy" which as I understand it used to be the GS ethic. I get that they need to generate commission–but knowingly selling bad product because the salesman needs a new pair of shoes is wrong. I mean, the guys in Glengarry Glen Ross are A-OK under the standard of buyer beware. Surely we can aim for a higher standard than the predatory pursuit of a bonus and quarterly "blowout" earnings.
In a product that is essentially zero-sum, it seems apparent to me that none of these experienced buyers would have balked just because a no-name hedge fund was on the other side. Someone has to be. It would be interesting to know if IKB or ACA owned the same mortgage products that are referenced in Abacus in any of their other CDO's, which would kind of blow the idea that they wouldn't have bought this one. That said, I do not know if the regs are that GS has to tell them anyway. Since some here seem to have experience in these products, does the bank (GS) or manager (ACA) have an obligation to choose the investments inside the CDO for the benefit of just the longs or the shorts? Or is it supposed to be representative of the class as a whole?
I do think that customers should understand that GS is just a broker matching buyers and sellers.
But clearly most people think they are much more sophisticated than a middle-man. They think they actually have insight into what makes a good business good.
And it is the reputation where they make money.
After all, do you really think all of those schlocky companies they take public would pay them 7% if GS did not promise a "buy" rating from their "research" staff?
Yet we could all give countless cases like Escentuals or ABACUS. I would point to Anthony Notto during the Internet bubble.
You would think that people would have only allowed Goldman to do that for a few years but that is not the case. Their reputation remains intact from bubble to bubble.
IMO, that is because people need some sort of anchor to gather around. It doesn't matter that it is not rational to anchor — it just matters that everyone else thinks that everyone else will anchor around it. And Goldman is that anchor.
It's quite an operational moat — I'm not sure how a competing business get around it.
Interesting that Pellegrini says he told ACA he was short… makes the SEC look like pikers as Jeff suggests, and doesn't enhance the late unlamented ACA's already poor reputation.
Then it looks like typical case of a broker blowing up a client to get out of a position, with an assist from ACA, as opposed to a diabolical scheme to get ACA to create a crap security on false pretenses and then use it to blow up clients.
Not great for GS's rep, but unless the SEC has a smoking gun, seems harder to make a fraud case stick.
http://www.finalternatives.com/node/12226
Dear Jeff,
I'm the reporter from HK. Would like to interview with you by email. May I have your email contact and send some details to you? Look forward to hearing from you.
Best,
Willa
Willa: rampartners@gmail.com; I look forward to setting up a conversation!
Jeff
Jeff I'd love to be able to quote the following passage in my own blog and would like your permission to do so with full information as to the source being provided.
not long ago we published in these virtual pages a column titled “Goldman 8, Public Zero…the Teachable Moment of Bare Escentuals (January 15).” It was a minor but explicit illumination of Goldman’s relationships with its clients—i.e. pretty much the same relationship a water moccasin has with a frog.
Loyal readers will recall that we described how Goldman Sachs first sold a total of 36 million shares of cosmetics maker Bare Escentuals (sic) to the public at prices ranging from $22.00 to $34.50. Then, after the wheels came off the proverbial track at Bare, Goldman’s crack research team slapped a “Sell” rating on the company’s stock…but not until after it had already collapsed to $13 a share.
Adding insult to injury, just a few weeks after that “Sell” rating—from Bare’s very own investment bank—sent the shares crashing, Bare Escentuals received a takeover bid for $18.20 a share.
But wait, as they say, there’s more!
Bare Escentuals then hired none other than Goldman Sachs to advise the cosmetics company on the $18.20 a share offer. Goldman, naturally, endorsed the price as fair—just weeks after its own research department had declared $13.00 as too rich a price for Goldman’s clients to pay—and received fees for doing so.
By our count, that amounted to eight ways Goldman Sachs made money on Bare Escentuals at the expense of anybody on the other side of the table.
Richard: Yes you may–and thank you for asking permission.
JM
Many thanks Jeff I've posted on my blog: richardstott.blogspot.com
Goldman took several good Internet companies public during the bubble, including Yahoo! and eBay.
But more importantly, someone in the comments unfairly criticized Anthony Noto (by the way, not Notto). Anthony had his faults as all of us do, especially including Wall Street's Finest. However, Michael Parekh and Tom Berquist were the Goldman analysts who concocted, shook, stirred, and drank the Kool-Aid during the era of magic Internet potions. Anthony was far more sane and far more humble than Michael and Tom and really didn't get involved until sometime in late 2000 or 2001. (By late 1999, the Webvan red herring was out, and I have a Pets.com red herring dated January of 2000–the patients were in charge of the insane asylum by then; no one could analyze anything because there were no numbers to analyze from anything that went public!)
Full disclosure: I am a retired buyside guy unrelated in any way to Anthony, Michael, or Tom except as an institutional client of Goldman.
–gjg49
Jeff,
Have you received my questions by email? Please let me know your thinking.
Thanks,
Willa
Willa: Yes, they are in your gmail.
Best,
JM
Rule 10b(5):
1. applies regardless of whether the purchaser of the security in question is a sophisticated investor, a widow/orphan, or any level of sophistication in between;
2. sets no standard of due diligence required on the part of the purchaser;
3. is not null and void because the ABACUS purchaser may have engaged in similar activities; a purchaser of BACCHUS may have a cause for action against IKB under 10b(5), but this should be totally separate from the issue with Goldman in the ABACUS case (unless these securities were somehow connected).
Still SEC 0, Goldman 0 with the SEC having a couple of men on base with nobody out in the first inning.
Our latest Anonymous, who sounds a lot like our friend Barry Ritholz before he's had his 16 coffees, makes the very obvious point that if Goldman broke the law–in this case Rule 10b(5)–then they broke the law no matter how bad or smart the guy other side of the trade was.
This argument ignores two points:
1) The SEC in its complaint accused Goldman of misleading IKB ('IKB would not have invested in the transaction had it know that Paulson had a significant role…'). The point of our "BACCHUS" piece is that this accusation doesn't look possible, based on IKB's own marketing documents. Does that apparent weakness in the SEC's argument not call into question the strength of the case? We think so. Barry does not. That's what makes markets.
2) Those who keep citing Rule 10b(5) as 'case closed' make the mistake of taking the SEC's accusation–that Goldman actually violated Rule 10b(5)–as a fact…when in reality all we have thus far are allegations that Goldman did so.
Given our Point #1, and the lack of any smoking gun in the complaint, we're skeptical about Point #2.
But, indeed, the score right now is 0-0 and time will tell.
JM
Jeff, you know more about running a hedge fund than most of us collectively would know in a lifetime. But I'm glad your not the SEC lawyer for this case. First, there is no level of sophistication required under the law being discussed – the question is whether GS lied. Telling someone that Paulson's fund is long when it's actually short is worse than nondisclosure, it's a complete lie. Secondly, why would the SEC lead with its best hand? Like any such case, and especially considering that GS will have the best lawyers in the world working for it, why would the SEC lead with anything more than the absolute minimum? They will only show their cards, and the extent of them, as required, not on the front end. Though you can be sure there are some folks at GS who know just how many smoking guns are out there. And where there's smoke, there's fire.
And I agree with the guy who said that anyone could have taken MSFT public, and it was MSFT that made money for people, not GS. GS is a middleman, pure and simple – they sell to the sheep, and the sheep buy it. As long as they stay out of the way of owning it themselves, they really couldn't care less how much anyone makes or loses on the other sides of the trade. Why should they? They've made a life of being the highest paid middlemen in the world, and that's not a putdown. On the contrary, to make so much money for doing so little is quite a feat. And we won't even get into the AIG payout or that Hank Paulson had a slight conflict of interest in all of those proceedings. The fun is just beginning.
From the economist, http://www.economist.com/opinion/displaystory.cfm?story_id=15951777
The Securities and Exchange Commission says Goldman misled two clients by failing to give adequate disclosure. At the urging of a hedge fund, Paulson, it enlisted an insurance firm, ACA, to select (with Paulson’s input) a pool of mortgage instruments upon which the security’s price would be based. The SEC alleges that Goldman misled ACA into believing that Paulson would co-invest with it. In fact Paulson was betting that the security would decline. The SEC also claims that IKB, a German state bank with a seemingly inexhaustible capacity for self-harm, was not told of Paulson’s role in helping pick the mortgages, a role the SEC argues was material.
Broken dealer?
Both of these possible offences are serious. Goldman denies the first outright, and on the second it argues that Paulson’s role was not material. The arguments appear finely balanced: the investigation has gone on for more than a year and the SEC’s top brass was divided over whether to proceed. It is impossible to second-guess the case’s outcome. But Goldman is already viewed by many as guilty. That fits a broader narrative in which it manipulated the bail-out and profited from economic misery. For those interested in accurate history, this is unfortunate. Some of Goldman’s links with the government were uncomfortably close. But the real story of this financial crisis, like many others, was not about one firm but near universal risk-taking, stupidity—and possibly widespread fraud.