Paulson and Goldman Sucks
Wednesday, April 28th, 2010Author Mike Rough
Is it just me or is something extremely wrong with the world of finances when Paulson & Co. Inc., is allowed to assemble a portfolio guaranteed to fail, and then bet against the CDO using default swaps purchased from Goldman, and are not being prosecuted for impropriety, or any number of violations of code and law?
Who is John A Paulson and exactly where is he getting his Teflon suites made, more importantly by whom?
On Friday the Securities and Exchange Commission charged Goldman Sachs with securities fraud for eliciting misleading statements and omissions to investors regarding collateralized debt obligation, or CDO, known as Abacus 2007-ACI.
According to the SEC filing Paulson advised Goldman regarding the structure of the deal and then bet against it, rendering huge profits when the housing market imploded in 2007. At issue is the omission by Goldman to investors of the CDO about Paulson’s involvement and true financial position when assembling the portfolio of sub-prime mortgages, and that Paulson was betting against the mortgages it had selected.
Again… How is Paulson not the bad guy here? You would think at some point the brain trust at Goldman would be taking note of the fact that their advisor was not buying a ticket on the big boat they had designed, and in fact had taken out insurance against it sinking.
What absolutely kills me is what the SEC had to say about Paulson’s involvement in the situation.
As stated in front of a congressional panel in 2008, Robert Khuzami, director of the SEC’s enforcement division, said Paulson wasn’t charged because it wasn’t obligated to disclose conflicts to investors.
“We charged those that we felt were appropriate based on the evidence,” Khuzami stated to the media via phone. “Goldman made representations to investors, and Paulson did not.”
Now I’m no financial litigator or investigator but when its spelled out like this in the SEC filing you have to ask what definition of “appropriate” the SEC is using :
Undisclosed in the marketing materials and unbeknownst to investors, a large hedge fund, Paulson & Co. Inc. (“Paulson”), with economic interests directly adverse to investors in the ABACUS 2007-AC1 CDO, played a significant role in the portfolio selection process. After participating in the selection of the reference portfolio, Paulson effectively shorted the RMBS portfolio it helped select by entering into credit default swaps (“CDS”) with GS&Co to buy protection on specific layers of the ABACUS 2007-AC1 capital structure. Given its financial short interest, Paulson had an economic incentive to choose RMBS that it expected to experience credit events in the near future.
Does this sound like collusion or at least insider trading to anyone else?
I find it interesting that the only statement made by Paulson was the following.
Paulson & Co. said in a statement that it wasn’t involved in selecting the collateral that went into the Abacus CDO, in contrast to the allegations in the SEC’s suit against Goldman.
Pay no attention to the very wealthy hedge fund manager behind the curtain…
Even by the SEC’s own admission, Paulson was complicit in their involvement of the manufacturing, marketing (by non disclosure), and then profiting off the failure of the products. This is clearly stated in the filing under the facts heading section C.
Laying the groundwork for the Con:
C. GS&CO AND PAULSON DISCUSS A PROPOSED TRANSACTION
15.
Paulson performed an analysis of recent-vintage Triple B-rated RMBS and identified various bonds it expected to experience credit events. Paulson then asked GS&Co to help it buy protection, through the use of CDS, on the RMBS it had adversely selected, meaning chosen in the belief that the bonds would experience credit events.
Defrauding Investors
16.
Paulson discussed with GS&Co possible transactions in which counterparties to its short positions might be found. Among the transactions considered were synthetic CDOs whose performance was tied to Triple B-rated RMBS. Paulson discussed with GS&Co the creation of a CDO that would allow Paulson to participate in selecting a portfolio of reference obligations and then effectively short the RMBS portfolio it helped select by entering into CDS with GS&Co to buy protection on specific layers of the synthetic CDO’s capital structure.
Admitting to Defrauding Investors
17. A Paulson employee explained the investment opportunity as of January 2007
as follows:
“It is true that the market is not pricing the subprime RMBS wipeout scenario. In my opinion this situation is due to the fact that rating agencies, CDO managers and underwriters have all the incentives to keep the game going, while ‘real money’ investors have neither the analytical tools nor the institutional framework to take action before the losses that one could anticipate based [on] the ‘news’ available everywhere are actually realized.”
Not only did Paulson select the mortgages that were initially in the offering they also modified it during negotiations with ACA through Goldman by removing Wells Fargo mortgage bundles further weakening the viability of the already questionable CDO:
34.
On February 5, 2007, an internal ACA email asked, “Attached is the revised portfolio that Paulson would like us to commit to – all names are at the Baa2 level. The final portfolio will have between 80 and these 92 names. Are ‘we’ ok to say yes on this portfolio?” The response was, “Looks good to me. Did [Paulson] give a reason why they kicked out all the Wells [Fargo] deals?” Wells Fargo was generally perceived as one of the higher-quality subprime loan originators.
Further evidence of Paulson’s involvement is stated regarding the marketing and purchase of protection against losses:
43. Although the marketing materials for ABACUS 2007-AC1 made no mention of Paulson or its role in the transaction, internal GS&Co communications clearly identified Paulson, its economic interests, and its role in the transaction. For example, the March 12, 2007 MCC memorandum describing the transaction stated, “Goldman is effectively working an order for Paulson to buy protection on specific layers of the [ABACUS 2007-]AC1 capital structure.”
If an individual was found manipulating a less sophisticated person into making bad financial decisions through their position of knowledge and authority, and then profited by those decisions indirectly, and leaving the manipulated person in ruins, wouldn’t there be an investigation and arrests? Even at the slightest hint of impropriety in the public domain an investigation for evidence is launched to absolve or convict the suspects. Knowing this, how can it be possible that Paulson is not rotting in jail right now, especially with the preponderance of evidence that has been found and detailed in this SEC filing?
I find it hard to be confident in extending the powers of the SEC to regulate Wall Street when recent scandals have blotted their reputation. Add to it the non filing of charges against Paulson and you have to wonder how much more latitude the elite financial players of Wall Street will gain. The bottom line will remain the same as long as the “Elites” are allowed to bend and break the rules by wielding power and influence through the lobbyists and political donations.
Something is rotten on Wall Street my friends and its high time we take Paulson out with the rest of the Goldman Sachs of trash.
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James the Wanderer says:
April 29th, 2010
1:53 pm
After this, the only defense a defrauded investor doing business with Goldman Sachs would have is insanity.
I have read at least a dozen articles in the last few months that describe how GS does business, and only a fool would enter into any trade that involves them.
Greece fails, a Ghana gold-company gets taken over, CDO’s, ABACUS … every deal they are involved in damages everyone involved except GS.
Reputation should mean something; due diligence should mean something. To me it means: no GS deals for me, in any level or fashion!
Not that they would be interested in me anyway, but just so…
james the wanderer
Desertrat says:
April 29th, 2010
2:32 pm
Thanks to Barry Ritholz and the Daily Reckoning:
“I have been watching with a mixture of awe and dismay some of the really bad analysis, sloppy reporting, and just unsupported commentary about the GS case.
I put together this list based on what I know as a lawyer, a market observer, a quant and someone with contacts within the SEC. (Note: This represents my opinions, and no one elses).
1. This is a Weak Case: Actually, no – it’s a very strong case. Based upon what is in the SEC complaint, parts of the case are a slam dunk. The claim Paulson & Co. were long $200 million dollars when they were actually short is a material misrepresentation – that’s Rule 10b-5, and it’s no brainer. The rest is gravy.
2. Robert Khuzami is a bad ass, no-nonsense, thorough, award winning Prosecutor: This guy is the real deal – he busted terrorist rings, broke up the mob, took down security frauds. He is now the director of SEC enforcement. He is fearless, and was awarded the Attorney General’s Exceptional Service Award (1996), for “extraordinary courage and voluntary risk of life in performing an act resulting in direct benefits to the Department of Justice or the nation.”
When you prosecute mass murderers who use guns and bombs and threaten your life, and you kick their asses anyway, you ain’t afraid of a group of billionaire bankers and their spreadsheets. He is the shit. My advice to anyone on Wall Street in his crosshairs: If you are indicted in a case by Khuzami, do yourself a big favor: Settle.
3. Goldman lost $90 million dollars, hence, they are innocent: This is a civil, not a criminal case. Hence, any mens rea – guilty mind – does not matter. Did they or did they not violate the letter of the law? That is all that matters, regardless of what they were thinking – or their P&L.
4. ACA is a victim in this case: Not exactly, they were an active participant in ratings gaming. Look at the back and forth between Paulson’s selection and ACAs management. 55 items in the synthetic CDO were added and removed. Why?
What ACA was doing was gaming the ratings agencies for their investment grade, Triple AAA ratings approval. Their expertise (if you can call it that) was knowing exactly how much junk they could include in the CDO to raise yield, yet still get investment grade from Moody’s or S&P. They are hardly an innocent party in this.
5. This was only one incident: The Market sure as hell doesn’t think so – it whacked 15% off of Goldman’s Market cap. The aggressive SEC posture, the huge reaction from Goldie, and the short term market verdict all suggest there is more coming.
If it were only this one case, and there was nothing else worrisome behind it, GS would have written a check and quietly settled this. Their reaction (some say over-reaction) belies that theory. I suspect this is a tip of the iceberg, with lots more problematic synthetics behind it.
And not just at GS. I suspect the kids over at Deutsche bank, Merrill and Morgan are working furiously to review their various CDOs deals.
6. The Timing of this case is suspect. More coincidental, really. The Wells notice (notification from the SEC they intend to recommend enforcement) was over 8 months ago. The White House is not involved in the timing of the suit itself; it is a lower level staff decision.
7. This is a Complex Case: Again, no. Parts of it are a little more sophisticated than others, but this is a simple case of fraud/misrepresentation. The most difficult part of this case is likely to turn on what is a “material omission.” Paulson’s role in selecting mortgages may or may not be material – that is an issue of fact for a jury to determine. But complex? Not even close.
8. The case looks thin: What we see in the complaint is the bare minimum the prosecutor has to reveal to make their case. What you don’t see are all the emails, depositions, interrogations, phone taps, etc. that the prosecutors know about and GS does not. During the litigation discovery process, this material slowly gets turned over (some is held back if there are other pending investigations into GS).
Going back to who the prosecutor in this case is: His legal reputation shows he is a very thorough, very precise, meticulous litigator. If he decided to recommend bringing a case against the biggest baddest investment house on Wall Street, I assure you he has a major arsenal of additional evidence you don’t know about. Yet.
Typically, at a certain point the lawyers will tell their client that the evidence is overwhelming and advise settling. That is around 6-12 months after the suit has begun.
9. This case is Political: I keep hearing that phrase, due to the SEC party vote. It is incorrect. What that means is the case is not political, it means it has been politicized as a defense tactic. There is a huge difference between the two.
10. I’m not a lawyer, but . . . Then you should not be ignorantly commenting on securities litigation. Why don’t you pour yourself a tall glass of “Keep Your Mouth Shut” and go sit quietly in the corner.”
Interesting times, indeed.
‘Rat
Linda Brady Traynham says:
May 11th, 2010
10:49 pm
Wow, you guys are great, and oh, so right. One interesting point…only 3 of the 5 Commissioners (or whatever they’re called) voted to move forward on this! I guess GS didn’t stock the panel heavily enough.